As soon as I saw it, I knew I’d struck gold.

Back when I was apartment hunting in West Palm Beach, I found one located near a new, high-speed train line.

That line played a big role in my decision to buy the unit in 2019.

The rail line outside Brad’s downtown West Palm Beach apartment

Not only do railways create convenience and add value to properties close to stations… But the industry also represents some of the widest moats in the investment world.

At Intelligent Income Daily, we bring you the best income-producing ideas our research uncovers. And the strongest opportunities are the ones that have withstood the test of time and maintain a competitive edge over up-and-coming competitors.

Today, I’ll tell you how the best railroads built their wide moats. And I’ll share the names of three safe, income-paying railroad stocks that are the dominant players in the space.

Digging a Wide Moat Over the Decades

Railroads in the U.S. are divided into three classes: I, II, and III.

For our purposes, we’ll examine Class I railroads. These are the largest with long-haul tracks and are the most profitable of the bunch. As of 2019, only those carriers that earn more than $504.8 million in revenue qualify for this designation.

Over a century ago, more than 100 companies held Class I status (the threshold was smaller back then due to inflation). However, consolidation in the industry has chiseled that total down into the single digits today.

Why is this?

Well, because it’s nearly impossible to overcome regulation and the high-capital investment hurdles associated with new, large-scale railroad projects.

It’s easier to just buy up existing tracks.

That’s why the most powerful and profitable companies in the industry acquired their competition over the years. Using mergers and acquisitions, they increased the size of their rail networks.

Now, only seven Class I railroads are responsible for moving most of the goods around the country and to and from ports.

And not only that, but as shippers and truckers faced disruptions during the COVID-19 pandemic… Railroads held up better than most. Their unique 24/7 business model and ability to move a lot of cargo with very few people gave them an edge.

The Numbers Don’t Lie

Throughout the pandemic period, we saw blue-chip railroad companies continue to improve their operating ratios.

In recent years we’ve seen trains get longer (enabling them to carry more goods) as well as train speeds increase, and loading times decrease.

There are three companies in particular that have differentiated themselves above the rest in on our research.

In Q4 of 2019, transport company CSX Corporation (CSX)‘s operating ratio was 60.0%. Then in the company’s most recent quarter, the ratio stood at 59.5%.

Norfolk Southern (NSC) on the other hand, had an operating ratio that was 64.9% in Q4 of 2019… while its most recent quarter’s ratio is 62.0%.

Finally, Union Pacific (UNP)‘s operating ratio was 59.7% in Q4 of 2019. But Union Pacific reported earnings yesterday, noting a 61.0% operating ratio during its most recent quarter.

UNP is the only U.S. class-1 railway to slip up in this regard; however, the company said that it expects to see “full year operating ratio improvement” in 2023, which should keep it on trend with its peers’ trajectories.

When examining railroad operating ratios, a lower number is better. The lower the ratio, the lower they’re keeping their operating costs while still generating revenue.

Overall, more efficient operations and increased shipping demands have allowed CSX and Union Pacific to increase their earnings-per-share by approximately 37% and Norfolk Southern to boost its bottom-line by approximately 33% since 2019.

We’re not the only ones who recognize the wide moat advantages to owning railroads (high barriers to entry) with little incoming competition…

Leading up to and during the financial crisis from 2007 to 2009, Warren Buffett purchased majority shares of BNSF Railway through his prized holding company, Berkshire Hathaway.

BNSF is a Class I railroad. And by purchasing it, Buffett displayed his confidence in railways’ long-term demand and their crucial role in the success of America’s economy.

When selecting sleep-well-at-night (SWAN) stocks, I always look for those that have competitive advantages over their peers… as well as potential disruptive competition.

And when it comes to railroad companies, the barriers to entry are sky-high now. So the last-standing Class I companies offer some of the most daunting moats in the entire stock market.

Simply put, I’m confident there will never be another new Class I railroad company.

That means the existing names are very appealing to me.

There’s only one problem with purchasing Berkshire shares to get exposure to BNSF, though…

The company doesn’t pay dividends.

Here’s the good news: The other six Class I railways do.

Railroad Dividends Keep Chugging Higher and Higher

I often say the safest dividend is the one that has just been raised. So here are three best-in-class railway stocks that should allow income investors to rest easily.

  • Union Pacific (UNP)

    During the past decade, Union Pacific shares are up by 210%. Meanwhile, the S&P 500 is up 165%.

    Union Pacific shares currently yield 2.5%. And the company is on a 16-year dividend increase streak.

    Union Pacific’s most recent dividend increase was 10.2% and the stock’s five-year dividend growth rate is 15.4%.

  • Norfolk Southern (NSC)

    Norfolk Southern shares have posted gains of 264% during the last 10 years.

    It currently yields almost 2% and is on a six-year dividend increase streak.

    Norfolk Southern recently increased that dividend 13.8%. That brings its five-year dividend growth rate to 15.2%.

    The company is expected to announce its 2023 dividend increase this week. Due to the stock’s strong performance during the last year, I believe another double-digit increase is likely.

  • CSX Corporation (CSX)

    CSX offers the best 10-year performance of the group, with shares up 332% during that time.

    However, this strong share price performance has pushed down CSX’s dividend yield, which now sits at 1.3%.

    But that doesn’t worry us because it’s still maintaining a trend of growth…

    CSX has been increasing its dividend for 18 consecutive years now. Its most recent dividend increase was 7.5%. And its five-year dividend growth rate stands at 9%.

As you can see, Class I railroads’ wide moats have resulted in growing earnings and expanding margins for years.

And this reliable fundamental growth has resulted in not only strong total returns, but also rapid dividend growth.

Owning best-in-class railroads isn’t just my favorite strategy when the Monopoly board comes out on game night…

Last year, my apartment’s rent increased 60%. While that part isn’t great, it means the value of the unit is also going up. Being in a central location, near a highly trafficked rail line, has paid off in that regard.

And I’m confident purchasing the resilient companies I highlighted in today’s essay or investments closely tied to them will also pay off in the future.

Happy SWAN investing,

Brad Thomas
Editor, Intelligent Income Daily

P.S. Wide moats come in all shapes and sizes. That’s why we dig deep into our analysis to identify the various advantages that give companies an edge over the competition.

In our flagship newsletter, Intelligent Income Investor, we select a new investment every month based on its superiority in its sector. Best of all, our recommendations offer dividend yields up to 8%. To learn how to become a member, click here.