Over the past six months, Norfolk Southern’s shares (currently trading at $222) have posted a disappointing 19.9% loss while the S&P 500 was down 4.7%. This 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? Get the full breakdown from our expert analysts, it’s free.

Why Do We Think Norfolk Southern Will Underperform?

Despite the more favorable entry price, 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 1.9% 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.Norfolk Southern Units Sold

2. EPS Barely Growing

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Norfolk Southern’s EPS grew at a weak 3% compounded annual growth rate over the last five years. On the bright side, this performance was better than its 1.8% annualized revenue growth and tells us the company became more profitable on a per-share basis as it expanded.Norfolk Southern Trailing 12-Month EPS (Non-GAAP)

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 10.5 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 13.7%.Norfolk Southern Trailing 12-Month Free Cash Flow Margin

Final Judgment

We cheer for all companies making their customers lives easier, but in the case of Norfolk Southern, we’ll be cheering from the sidelines. After the recent drawdown, the stock trades at 16.9× forward P/E (or $222 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are better stocks to buy right now. We’d suggest looking at our favorite semiconductor picks and shovels play.

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