Norfolk Southern, a Totally Cool Stock
Tue, 17/08/2010 - 10:19 by David Meier
Leading the Vanguard Windsor Fund, John Neff beat the market by more than three percentage points per year for more than 30 years. That's an incredible track record and the difference between $39,116 and $17,449 on a $1,000 investment, assuming a 10% average return. Here's the master's secret: Two of those three percentage points came from dividends. So while Neff worked hard to buy cheap stocks, dividends were crucial to outsized returns. That's totally cool!
To help find totally cool stocks that offered value and income, Neff used his total return ratio, defined as:
Total Return Ratio = (analysts' expected earnings growth rate + dividend yield) / price-to-earnings ratio
Neff would compare company ratios to the market's ratio. If a company's ratio was at least 50% greater than the market's, he gave it look. If Neff's research revealed the market misinterpreted the company's prospects and thus created an opportunity, he purchased shares for the portfolio.
Currently, the market's total return ratio is about 0.95. (I used a Shiller P/E of 20.1, a yield of 2%, and two-year estimated earnings growth of 17.2%.) So to meet Neff's criteria, a company's ratio must be greater than 1.43.
Let's look at the table below to see Norfolk Southern (NYSE: NSC) might be a total return opportunity.
Total Return Ratio
Norfolk Southern Corp.
CSX Corp. (NYSE: CSX)
Genesee & Wyoming Inc. (NYSE: GWR)
According to the numbers in the table, Norfolk Southern looks more attractive than competitors CSX Corp. and Genesse & Wyoming. It pays a higher dividend and analysts expect higher earnings growth. That's not a bad deal for a well-run railroad.
The Foolish bottom line
Neff's total return ratio is beautiful because it combines value and income: cheap stocks with dividend kickers. Investors can profit from multiple expansion while collecting dividend payments along the way. And as Neff showed, done correctly, this strategy can lead to excess returns over the market. As with any metric, Neff's total return ratio is just a starting point. But with a total return ratio of 1.63, Norfolk Southern certainly seems like a totally cool stock to get to know.
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