NEW YORK -- As the outlook for 2002 improves, analysts continue to warn investors that some stocks and sectors may already be factoring in those prospects, CBS MarketWatch.com reports.

Morgan Stanley analyst James Valentine told clients Wednesday that railroads are already priced for a full recovery, with stocks such as Burlington Northern Santa Fe, Canadian National, Canadian Pacific and Union Pacific having already hit his "post-recession" price targets.

Against that backdrop, Valentine sliced his "outperform" recommendations on the four railroads to "neutral," saying he believes the rail stocks are near the top of their recent run.

Burlington Northern shares dropped 70 cents, or 2.4 percent, to $28.25; Canadian National fell $1.02, or 2.2 percent, to $45.82; Union Pacific lost 89 cents, or 1.5 percent, to $58.36; and Canadian Pacific dipped 5 cents to $20.03.

"Our investment thesis to own the rails was on the prospect of a cyclical rally, which we expected to occur when signs of an economic recovery began," Valentine wrote in a research note. "Although we have yet to see any meaningful pick up in railroad, trucking or air freight volumes, the financial markets are willing to support valuation levels that suggest a full economic recovery is near."

Collectively, he noted, the railroads are within 3 percent of their 20-year peak valuations and are priced for almost peak operating margins in 2003.

"The results of a comprehensive shipper survey combined with our industry knowledge lead us to conclude that we shouldn't expect railroads to exceed former peak margins any time soon," Valentine said.

In fact, he said, he could continue recommending the names at this point only if he believed the industry would exceed best-ever margins in the next year or two. This, however, seems unrealistic, he said. Valentine said margin improvement as the economy recovers remains easy, but that the railroads will continue to face many of the challenges that have kept earnings growth in check since the industry was deregulated in 1980.

Valentine acknowledges the call could be too early and that it was entirely possible valuation would have no impact on the stocks.

"As with the tech sector from '97 to '99, news flow can drive stocks more than valuation, which is possible with the rails as the economy picks up and if oil prices remain low," Valentine said. "Looking at how well the railroad stocks rallied before the current recession even began and then again before there were any signs of an industry recovery, suggest to us that there may be more focus on the potential direction of earnings as opposed to the absolute level of earnings that can be achieved in the next few years."

And even with the downgrades, Valentine said it doesn't mean investors should sell out. "We're not against owning a railroad as a long-term stable investment, but we are cautious about expectations that there be substantial upside in the near-term."

For investors who must own a railroad to maintain an S&P weighing in the group, Valentine recommends Canadian National.

"It is one of the only carriers to earn its cost of capital and continue to grow its free cash flow," Valentine said. "Furthermore, CNI received the highest marks from customers in our recent survey, which suggests that it has the greatest long-term prospects for growing its top and bottom lines."