Railroad stocks are chugging higher as outlook brightens

The surprising revival of railroads as a growth industry has barreled ahead over the past year on a newfound ability to raise prices.

It represents a round-trip in American history.

Railroads inspired dozens of songs, from "On the Atchison, Topeka and the Santa Fe" to "Chattanooga Choo Choo," "City of New Orleans" and "King of the Road."

Railroads had ushered in the modern stock era, with nine railroad stocks on an 11-stock Dow Jones index launched in 1884.

The premier growth industry of that time, railroads were the only shares traded in large volume on the New York Stock Exchange. Early investment libraries were dominated by heavy tomes of rail data.

The mighty railroads eventually were derailed as growth investments, victims of changing transportation trends and then deregulation.

"It used to be that the costs of invested capital for a railroad were higher than the returns generated," said Art Hatfield, analyst with Morgan Keegan & Co. in Memphis. "You don't want to own stock in a company like that."

For their shareholders, the slow ride seemed to last forever.

"If you go back even to 2000, these were pretty sleepy stocks," said Rick Paterson, analyst with UBS Investment Research in New York. "They didn't generate much cash flow or earn their cost of capital."

In 2004, railroad stocks began to chug back into the station as growth investments. That's because the U.S. industrial economy was running smack into a consolidated railroad industry that was already running out of capacity.

In addition, there was an increase in import goods to transport, and the trucking industry was facing high fuel prices and driver shortages. Railroads were able to increase their prices.

Despite reduced freight volume stemming from the economic slowdown in housing and automobiles this year, some notable investors can't seem to get enough of railroads.

Most notably, Warren Buffett's Berkshire Hathaway now owns an 11 percent stake in Burlington Northern Santa Fe Corp. and smaller pieces of Union Pacific Corp. and Norfolk Southern Corp. Icahn Management LP and several hedge funds also have made significant investments in railroad stocks.