Norfolk Southern has had an impressive run over the past six months as its shares have beaten the S&P 500 by 5.2%. The stock now trades at $280.02, marking a 10.5% gain. This performance may have investors wondering how to approach the situation.

Is there a buying opportunity in Norfolk Southern, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

Why Do We Think Norfolk Southern Will Underperform?

We’re glad investors have benefited from the price increase, but we don't have much confidence in Norfolk Southern. Here are three reasons why we avoid NSC and a stock we'd rather own.

1. Weak Sales Volumes Indicate Waning Demand

Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Rail Transportation company because there’s a ceiling to what customers will pay.

Over the last two years, Norfolk Southern’s units sold averaged 2.9% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability.

2. EPS Barely Growing

We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.

Norfolk Southern’s EPS grew at an unimpressive 5.8% compounded annual growth rate over the last five years. On the bright side, this performance was better than its 3.5% annualized revenue growth and tells us the company became more profitable on a per-share basis as it expanded.

3. Free Cash Flow Margin Dropping

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

As you can see below, Norfolk Southern’s margin dropped by 7.8 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal increasing investment needs and capital intensity. Norfolk Southern’s free cash flow margin for the trailing 12 months was 17%.

Final Judgment

Norfolk Southern doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 20.9× forward P/E (or $280.02 per share). This valuation tells us a lot of optimism is priced in - we think other companies feature superior fundamentals at the moment. We’d suggest looking at the most entrenched endpoint security platform on the market.

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