Investors often have a set of metrics that they use to analyze and value each company they investigate. Each of these metrics can be useful, but it is dangerous to apply one set of analytical tools to all companies. Instead, investors should customize the set of metrics used to evaluate potential investments on a company-by-company basis.
For instance, investors who are interested in investing in a bank are not going to put much emphasis on its price-to-earnings ratio or operating margin. Instead, investors should focus on a bank’s return on equity and price-to-book (or price-to-tangible book) because those metrics are more relevant to the analysis.
Sometimes, investors may need to create their own metrics to evaluate a company. For instance, EBITDA per room may be usefulwhen comparing one hotel’s profitability to another. However, plain vanilla metrics usually work just fine.
Key to railroad analysis: return on assets
Since railroads are capital intensive, it is extremely important that the firms utilize their assets in the most efficient manner possible. Return on assets — net income divided by total assets — is a simple way of measuring how efficiently a railroad uses its assets.
Union Pacific Corporation (NYSE:UNP) is an example of a railroad that has started to utilize its assets more efficiently as of late. The rising price of oil has boosted rail traffic industry-wide, but Union Pacific has magnified the effect by making significant improvements to its cost structure. As a result, the company raised its return on assets from 4.5% in 2009 to 8.4% in 2012 — an enormous improvement that makes it one of the most efficient operators in the industry.
What’s more, the frothy state of the railroad industry is allowing the company to re-up expiring long-term contracts on favorable terms; return on assets may yet improve even more as a result.
Kansas City Southern (NYSE:KSU) is on the other end of the spectrum from Union Pacific Corporation (NYSE:UNP). Having grown assets at about the same rate as sales over the last decade, the railroad has struggled to improve its dismal return on assets (it earns a low- to mid-single digit ROA).
But Kansas City Southern can improve its return on assets if it can increase traffic on its track. Instead of relying on its own cars to earn the bulk of its profits, the firm offers concessions to other railroads so that it can utilize all of its capacity. This should, in theory, lead to above-average return on assets, but management has yet to achieve this feat.