Airline Stocks are Taking Off!

In late 2015, I began work on my stock investment strategy for 2016.  I took a sector and industry approach—which sectors and industries were likely to do well as the US economy improved, as seemed likely? Among other conclusions, I decided that airlines might be a hot industry in 2016.

My reasoning was that as the US economy continued to recover, and employment rose, that people were going to have more discretionary income and possibly take more trips. And when I looked at airline stocks, some of them had sound financial statements and had increased sales and earnings in both 2015 and 2014. Some of the best were regional players, such Alaskan Airlines and JetBlue. Also Southwest Airlines which—although no longer a regional airline—retains the culture and habits of a smaller airline.

I was also looking at fuel prices, which are a major cost for airlines. I did not see oil prices going up in 2016. With the economy recovering and fuel prices at an extreme low, how could airline stocks not rise?

I made a vast spreadsheet and memorized the definitions of airline metrics, such as ASM, PRASM and CASM. (“Average Seat Mile”—a measure of capacity; “Passenger Revenue per Average Seat Mile”—a measure of revenue versus capacity; “Cost per Average Seat Mile”—a measure of cost divided by capacity.) I was an eager student.

Then I made my investments, which I structured as trades even though I imagined these stocks rising steadily throughout the year. In a trade, if the stock declines by so much, you sell it—and if it increases by so much, you sell it. A trade is a temporary investment.

All my trades exited on the low side; Alaskan and JetBlue struck out repeatedly. I didn’t buy Southwest; I thought I’d start with the smaller airlines, which had shown more growth recently than Southwest, and then later buy Southwest. But I lost money on every move I made. On the first couple of trades, I was so convinced that they were winners that when they fell to the exit point (that I’d previously decided on), I kept them until they fell significantly further. I was stubborn about airlines. Okay, maybe they’re not going up now, but one more day!

In investing, this is like the moment in backpacking when you’re lost and you think, “this compass is broken!” Because the worst part of being lost is not knowing it, and the worst part of not knowing it is violently denying it.

And I was influenced by the concerns, frequently expressed in the financial press, about the stock market being “over-valued,” which means that company earnings are too low to justify the stock price. There’s a metric, “price to earnings ratio,” (P/E), that captures this relationship. A good P/E varies from industry to industry, but in this day and age any P/E under 20 is at least decent, and plenty of good stocks have a P/E over 20.

My airline stocks all had good P/E. Alaskan Airlines had (at that time, in December 2015) a P/E of 13.05, quite presentable, with a forecast P/E of 12.5, over the next 12 months. JetBlue had a P/E of 13.52 with a forecast P/E of 11.8. And the prediction for JetBlue’s growth was phenomenal. Its PEG (P/E divided by its growth rate) was .25, an amazing figure, especially when you realize that “any PEG under 1.0 is good” as one source put it.

And I had other metrics, lots of them: sales growth, return on equity, net profit, return on assets, debt-to-equity ratio, plus the “ASMs,” the airline-specific metrics. And JetBlue looked outstanding on all the metrics. And it had a good culture and seemed poised for growth.

Here is what happened to JetBlue’s stock price in 2016:

As of September 22, the stock is down 21% for the year. What happened? It’s hard to say, but fear of terrorism is sometimes noted in the press. Flights are mostly full, but the airlines haven’t been as aggressive at raising fares as they might have been. (Do they sense a softness in demand?)

Fuel prices remain a bargain. And if the airlines are under wage pressure, I haven’t heard about it.

From my point of view, the stock didn’t go up because it didn’t go up. I don’t see any convincing explanations.

It’s certainly not due to financial mismanagement either. JetBlue’s current P/E is 7.64. No, that’s not a typo. JetBlue’s P/E has fallen by nearly half in 10 months, and the market has rewarded that with a 21% decline in its stock price. According to the tenets of fundamental analysis, people should be rushing out into the streets to buy this stock. Mobs of investors should be forming on street corners.

And Alaskan Airlines, my second favorite airline last year? Its stock declined by 16%, while its P/E improved to 9.24.

The financial press seems to have a guideline—that about 10%-15% of all articles assert, with breathtaking confidence, that the stock market will go up only when the average P/E reaches 15 or 12, or some other number that was popular in Grandpa’s day. And if the market goes up anyway, then this will all end in tears.

But my message is different. Anytime you think you have a sure thing, consider your methodology. Fundamental analysis is so rigorous and quantitative that it seems almost infallible. But the economy is not a closed system. Anything can affect the economy, and the markets that reflect it—and that “anything” may or may not be visible to fundamental analysis, because no methodology includes everything.

Anything, anything, anything.