Thursday, September 20, 2012

Stock Bought: NSC

Today I bought shares of Norfolk Southern (NSC), a major North American railroad company. This is the third time I have added to my position in NSC this year, with previous purchases occurring in January and March.

NSC dropped over 9% today after the company lowered its Q3 earnings outlook (other railroad stocks also fell on the news). Continued declines in coal and merchandise shipments are expected to reduce revenues, although these effects will be partially offset by growth in intermodal volumes. While this news is disappointing, I consider it to be a short-term problem that will not dampen the company's long-term growth prospects. Coal volumes have been lower this year due to unusually warm winter weather, but this trend will likely flatten out or reverse once we return to more normal winter temperatures.

Despite the warning about earnings, I think management continues to have a positive view of the company's future. A strong indicator is the fact that NSC has increased its dividend twice this year, by 9.3% in January and by 6.4% in August. Note that the August dividend increase occurred after coal volumes had already been declining for several months. I think the company has responsible management and they would not grow the dividend in this manner if they were worried about future earnings.

From a valuation standpoint, I consider NSC to be undervalued with a P/E of 11.3 (its historic P/E is about 14.4), P/S of 1.9, and PEG of 0.88. Even if one were to lower future earnings expectations, the PEG would still likely be near 1. Today's drop in stock price pushed NSC over the 3% yield point ($66.67) and if you look at its historic yield over the past 10 years, it rarely stays above 3% for a long time. Using a Dividend Discount Model with a projected dividend growth rate of only 8% (which is well below historic averages) and a discount rate of 11%, I calculate a fair value of $72 for NSC, which I think is an extremely conservative estimate.

I bought 20 shares of NSC at the price of $65.98 per share, giving me a total of 70 shares at an average price of $70.25 per share and a 2.83% yield on cost. Note that I was able to average down from my previous cost basis of $71.96. At the current dividend rate, I can expect to receive quarterly dividends from NSC of $35.00, which is $10.00 more than what I was getting before this purchase. NSC will now contribute a total of $140.00 to my annual dividend income, which is $40.00 more than before. This purchase makes NSC the second-largest position in my portfolio, slightly behind MCD and slightly ahead of PM in market value.

It was nice to deploy some cash after a summertime lull. With the market near an all-time high, it has been difficult to find undervalued stocks. For that reason, it seemed appropriate to take advantage of the major drop in NSC today to lower my cost basis and increase my ownership of a great company. I still have enough cash on hand to make two more purchases, so hopefully Mr. Market gives me more good buying opportunities.

11 comments:

  1. DGM,

    Great minds think alike!

    I also purchased NSC when there was blood in the streets. Feels good!

    No matter how you slice it NSC appears to be undervalued, and this stock definitely has solid fundamentals with great dividend growth.

    Best wishes!

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    1. Dividend Mantra: Great minds certainly do think alike! I'm glad to hear you also took advantage of today's drop. I think NSC will serve us both well.

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  2. Count me in too fellas! I may have been a little too hasty... probably b/c the "discount" overwhelmed me.

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    1. FI Fighter: I'm glad to hear you got in on the deal, too! I was fortunate that I didn't check my stocks until late in the morning, by which time NSC had dropped about 8%. I watched it quickly fall another percentage point and then decided I could not pass on the opportunity, so I placed an order that was filled a few minutes later.

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    2. Yeah, I was watching the stock pretty carefully this morning at market open. It dipped for awhile, but as soon as I saw a spike in the positive direction, I decided to jump in.

      You got in at a great price! Here's hoping we have some more buying opportunities in the months ahead.

      Cheers!

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  3. Congrats to everyone who got in on this sell off. I still like the company long-term and will add more shares on further weakness. It is amazing what discounts Mr. Market throws at us when we are patient.

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    1. austinbroker: Thanks! Mr. Market certainly has some strong reactions -- I think it's fair to say that this sell-off was overdone.

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  4. I bought 20 shares this morning at $65.78. Couldn't pass up the chance to add to my position when it's offering more than a 3% yield. You have to love it when Mr. Market gives us great opportunities like this. I love being greedy when others are fearful.

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    1. Chad: Nice purchase -- I'm glad you also got in on this great deal.

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  5. All aboard the NSC train! I also bought some shares. I was completely unaware of the huge drop until Friday, but luckily it stayed low for another day and my limit order filled. I see it's even lower now...

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    1. Compounding Income: Nice purchase! It's possible NSC could continue to trend lower for a while, but I have no way of predicting that, so I figured I should take advantage of what Mr. Market offered me at the time. It seems like a lot of us young dividend growth investors did that!

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