A few weeks ago I named railroad stock Union Pacific (NYSE: UNP) as the most undervalued name in the S&P 500. That stance hasn’t changed. But, being the most undervalued name in the large-cap world doesn’t mean it’s the most potent railroad stock out there. As is so often the case with most industries, there’s a small-cap stock in the railroad group that’s even more attractive than the top large-cap stock.

For the railroad group, that stock is Trinity Industries (NYSE: TRN) — a $2.9 billion company that’s been on a tear for the past three quarters, with its stock in tow.

Just to set the stage, I like Union Pacific for multiple reasons, including a better-than-average valuation, a strong trailing earnings growth rate of 53.6% and a pretty wide trailing profit margin of 16.4%. I love Union Pacific, however, because it is simply a great company in a great business at a great time… a true “total package” of a quality investment.

And how does Trinity stack up? To be fair, comparing Trinity to Union Pacific isn’t exactly apples-to-apples. Well, maybe it’s red apples to green apples.

Where Union Pacific is a straight-forward railroad outfit, Trinity Industries supports and serves the railroad industry by building and repairing all sorts of rail cars (everything from box cars to gondolas to tank cars), plus the parts to maintain them. It also manufactures and outfits barges, sells aggregate (gravel, stone, sand, etc.) and other construction materials and even builds wind-power equipment. Its meat and potatoes, however, is the railroad business. Therefore, for the same reason Union Pacific is in the right place at the right time, so is Trinity. [For more on those reasons, see my original article here.]

And as it turns out, the rail market continued to grow through March. Rail freight was up 3.4% on a year-over-year basis last month, being at the strongest levels we’ve seen since the two-year downtrend in rail freight activity stopped and reversed in early 2010. Some experts think rail demand will meet its prior peak levels (from 2007) by 2012. Once there, steady growth is anticipated after that.

Yet on paper, Trinity Industries’ trailing results don’t even hold a candle to Union Pacific’s. The stock currently trades at 44 times its earnings, boasts a net profit margin of only 3.0% and is sitting on a lackluster return on equity of only 4.1%. None are anything to write home about.

So how can I still consider it a superior play to its bigger brother? It’s not what shows up on paper — or what’s in a company’s past — that makes a company great. Instead, it’s all about the future and the stuff you can’t easily quantify about a company that makes a stock great. That’s where Trinity starts to shine.

For instance, for the first time in years, Trinity’s earnings are starting to grow rather than shrink. Though on an annual basis the company managed to do worse in 2010 than it did in 2009 (which was somehow worse than 2008 on the earnings front), the corner may have been turned as of the first quarter of last year. During that quarter, the sequential shrinking of earnings finally reversed course and earnings growth was revived. Income still isn’t back to its peak levels, but at least it’s trending that way. Better still, considering the company topped estimates in each of the past three quarters, one has to wonder if 2011’s expected earnings of $1.47 per share still underestimates the railcar manufacturer.

Of course, the fact that 2010 was a rough year for Trinity should raise a red flag. Most every other company out there is well into recovery mode. How come this company isn’t? Is there a lurking problem?

No problems — just the nature of the beast. The railcar business is one built on long-term contracts and long-term order turnarounds (for better or worse). Trinity’s business did fine in 2008 and early 2009 because it was still delivering goods ordered well before the economic implosion materialized. Likewise, though the economy started to rebound in early 2009, railcar buyers with more than enough equipment to meet crimped freight demand at the time have been hesitant to place new orders.

That’s starting to change though, as GATX Corp. (NYSE: GMT) just inked a deal with Trinity to purchase more than 12,000 tank and freight cars in the next five years. The fiscal details of the agreement were not publicly shared, but these rail cars are priced anywhere from $40,000 to $100,000 each (depending on the type), putting the deal’s value somewhere in the ballpark of $900 million. For comparison, that figure is almost half of the $2.1 billion Trinity had in revenue last year. Not bad…

That’s not to say one contract makes or breaks a company, but both companies said the contract provides a stable [fiscal] outlook for the coming years. And, if GATX needs more cars, it’s likely other competitors need more cars, too.

As for what this boils down to in quantifiable terms for Trinity, 2011’s expected EPS of $1.47 translates into forward-looking P/E of 24.8, while 2012’s forecasted EPS of $2.35 translates into a forward-looking P/E of 15.5, a stark improvement from today’s high multiple.

The question is one of plausibility: Can Trinity actually reach those earnings levels? Yes, it can and it shouldn’t even be that tough. The company hit its peak earnings per share of $3.65 in 2007. It would only need to reclaim two-thirds of that level to hit its target. Indeed, adding in the fact that it’s expanding its construction aggregate business to better tap that multi-billion dollar market, it would be surprising if Trinity didn’t at least meet its expectations.

Action to Take –> In the very short run, Trinity Industries shares are overbought thanks to the 20% pop of the past month, so it would be best to wait for a dip before stepping in. Just don’t wait too long. With an average expected earnings growth rate of 67% for the next two years and a slew of upgrades starting to come out of the woodwork, the 30-40% one-year upside for this stock could be realized sooner than later.