News Analysis date published New: 
Friday, February 18, 2011 - 12:30

Is This the Most Undervalued Stock in the S&P 500?

Friday, February 18, 2011 - 12:30pm

How many ways are there to value a stock? Too many, which is why the market's participants rarely agree on which stock truly is "the most undervalued" name. That one-dimensional approach, though -- where a measure like a price-to-earnings (P/E) ratio or earnings growth is used as the yardstick -- is the very reason the hunt for value doesn't always find a winner. A truly undervalued stock looks good by all the relevant measures.

Such an approach certainly whittles down the number of truly great candidates, but that's the whole point. And which stock in the S&P 500 is the most undervalued right now? It's (drum roll please…) railroad company Union Pacific (NYSE: UNP).

To be clear, Union Pacific isn't more attractive than any other S&P 500 constituent based on any one single criterion. It is, however, near the top of the leader board for the greatest number of criteria, making the sum of those numbers the compelling aspect that makes it worth considering for your portfolio.

Take its P/E ratio for instance. Union Pacific's trailing-twelve-month P/E is 17.7, compared with an industry average of 18.2. It's also currently sporting a forward-looking P/E multiple of 12.8. For comparison, the S&P 500's trailing P/E is 16.0, and the projected one (2011) is 13.9.

Union Pacific has also been growing its bottom line, beefing up full-year income by 53.6% in 2010. This year's profits are anticipated to grow by another 18.0%. Of course, considering the rail carrier has topped estimates in three of the past four quarters, the outlook may not do the stock justice.

And the S&P 500's earnings growth rate? Annual profits were higher by 47.1% in the past twelve months, and are projected to grow by 14.9% in 2011.

Clearly Union Pacific's numbers are better than the market, but not leaps and bounds better. In fact, there are several companies with stronger earnings growth when looking back, as well as looking ahead (if not both).

So if it's not tops in terms of P/E ratios or earnings growth or other measures, how can Union Pacific be the most undervalued stock out there? This is where it pays to embrace the bigger picture and not fixate on just one criterion.

It doesn't make a comparison for every single possible valuation number, but the table below pits Union Pacific's most important numbers against the broader market. Take a look.

You can find individual stocks in the S&P 500 that look better based on one criteria or another, but you won't many -- if any -- that look as good as Union Pacific does across the board. There's literally nothing to complain or worry about -- not even a slightly frothy price-to-sales (P/S) ratio of 2.8.

While the numbers look good, there's one more reason why I think Union Pacific is the S&P 500's most underappreciated name; it's also simply a great company in a great industry at a great time.

Rail traffic was up 7.3% in 2010, and that trend has carried through so far into 2011 on the heels of continued economic growth. Year-over-year rail activity was up 8.0% in January, so the trend is actually accelerating. There's no end in sight to that increase, either, as long as nothing unexpected hinders a recovery. That means a well-run company like Union Pacific is perfectly positioned for growth this year, even if most investors don't recognize it yet. That, in fact, is the whole reason the stock is still undervalued… for now.

Action to Take --> It's fun to scoop up stocks of companies leading the latest social trends, but being a high-profile name doesn't automatically mean there's money to be made in blazing a trail. Sometimes, the best opportunities may be a little boring by comparison, but many of these same companies post bulletproof accounting statements. In that regard, Union Pacific offers the near-perfect total package right now.

Union Pacific is undervalued by as much as 20% at this point, and could make up at least that much ground in 2011 if it continues to grow income as expected.

Investors who are willing to hold it even longer, however, could feasibly see a gain of 50% or more within the next couple of years. Remember, Union Pacific has posted more than a few earnings beats recently, and as the economy's growth speeds up, rail carriers are positioned to be one of the top beneficiaries.

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James Brumley does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.