Earlier this week, I wrote about using Dow Theory as a way to gauge general economic health and also to potentially identify pockets of the economy that could yield attractive investment opportunities. The basic principle I worked from is the idea that indices must confirm each other in order for a conclusion that a particular segment market is experiencing healthy business conditions.
Remember that industries and sectors may operate in different areas and provide different products and services, but the interconnected nature of the economy means that those industries and sector also work to support each other. The confirmation principle of Dow Theory implies that when you compare two indices that track different, but complementary industries, a rise in one should naturally translate to a rise in the other.
The most classic example of this was first postulated by Charles Dow himself in the late 19th century, using the Dow Jones Industrial Average in concert with the Dow Jones Industrial Average. It makes sense that if industrial stocks – such as manufacturing and heavy machinery companies, to name just a couple of examples – are moving up, then the transportation stocks – railroads, trucking and shipping companies, and so on – that help those industrials get their products to market should also rise. The truth is that you can apply the same principle to any combination of industries or sectors in the market, as long as you can identify a complementary relationship between them.
As I ran through my Dow Theory-inspired analysis, I was intrigued by the fact that Charles Dow’s classic case applies to current market conditions. Over just the course of the month of May, the Dow Jones Industrial Average is up about 4%, while the Dow Transports are up a little over 6% over the same period. Being able to identify a thriving area of the economy is pretty exciting, but as a value-oriented investor, it also begs the question of where the best opportunities are likely to be right now. As I started to run through the twenty stocks that make up the Dow Transports average, there were really just two that clearly bubbled up to the top. Mr. Dow would love the fact that one of them is a railroad, while the second is a national trucking company that should be recognizable to anybody that spends any time on the freeway.
Kansas City Southern (KSU)
Current Price: $112.04
KSU is a mid-cap company ($11.5 billion market cap) with railroad operations that focus on the north-to-south freight corridor that connects commercial and industrial markets in the Central United States with industrial cities in Mexico.
KSU pays a dividend of $1.44, which translates to an annual dividend yield of about 1.28%. That isn’t very high, but it is also a reflection of the company’s management style, since it also translates to a conservative payout ratio of only about 27% of earnings. Their free cash flow is healthy and has grown in each of the last four quarters; just as importantly, they have an overall trend of increasing free cash flow that extends all the way back to the first quarter of 2014. Debt is manageable, and the company’s Return on Equity (ROE) and Return on Assets (ROA) are also both attractive.
The stock’s price activity for the past several months also offers a good reason to be bullish. Let’s take a look.
The stock has hovered in a range of approximately $12 per share from December 2017 to the current date. It is currently just a little below the range high a little above $113, and the truth is that most technical traders would not be anxious to make a trade on this stock right now. The opportunity in this case comes from the upward sloping trend line from March to today’s close; that has allowed the stock to establish a pattern of higher lows, with concurrent higher highs that demonstrate the stock has been building some good bullish momentum. If the stock breaks the resistance line and reaches $114, there should an attractive opportunity to take advantage of the momentum that should follow.
The range between the support line at around $101.50 and resistance in the $113.50 area can be used as a guide to identify the potential opportunity if such a breakout actually materializes. The next stop for the stock from that point could easily be at around $126 per share, which over either a short or intermediate time frame should mark an attractive opportunity for any investor. This technical perspective of the company’s potential upside is also supported by the fact the stock’s Price/Book ratio is currently 16% below its 5-year historical average.
Ryder System, Inc. (R)
Current Price: $69.16
While Ryder is a smaller company than KSU with a market cap of about $3.7 billion, it still fits in as a mid-cap stock, and as one of the largest players in the Trucking industry. The company leases and rents trucks, tractors and trailers throughout the United States, Canada, and the United Kingdom, and offers dedicated transportation and supply chain distribution and transportation in the United States and Asia.
R pays an an annual divided of $2.08 per share, which translates to an attractive annual yield of almost 3%. Their payout ratio, at 66%, is not as conservative as KSU, but also does not pose a challenge to the company’s overall balance sheet. Debt is also higher in the aggregate, but still manageable, as the company’s operating profits are more than adequate to service the debt they hold. Operating profits, manageable debt, and ROE and ROA are both high enough to offset the company’s negative cash flow pattern over the last three quarters to support a mostly bullish fundamental view of the company.
The most interesting reason you should be paying attention to this stock right now comes from its price activity.
The stock has been following a strong downward trend since late January, finding strong support in the $67 to $69 level since late April. Late this week, the stock began to show some signs of life, rising a bit and starting to demonstrate some bullish momentum. This stock has been a laggard among Transportation stocks, which as I’ve already mentioned has risen a little over 6% over the past month; but that could also provide an opportunity right now that a lot of investors haven’t started to pay attention to.
The stock’s nearest resistance level is around $77 per share, which is a little over 10% above the stock’s current price. That’s a pretty attractive spread for either a short or intermediate-term trade, and the stock’s 52-week high at around $90 works as a good long-term target price. That long-term view is bolstered even more by the fact that R is currently trading at a Price/Book Ratio of only 1.28, versus a five-year average ratio of 2.1. That’s a 64% difference that suggests a long-term high in the $90 range isn’t unreasonable by any stretch of the imagination.