Why would anyone buy an airline stock?
COMMENTARY That American Airlines parent AMR would file for Chapter 11 bankruptcy, as it just did, should have been no surprise. The only question was when it would happen. The signs were there in 2008, according to experts, and the big countdown started last year.
All that raises an interesting question: Given how American Airlines, or the industry as a whole, has done over the years, why does anyone invest in airline stocks? The answer is a bit complicated, but comes down to human nature and wishful thinking.
They think they can, they think they can
Airline stocks have always been best as a short-term play, according to research firm CreditSights airline analyst Roger King. "[People] buy them for short-term upside," he says. "Over the years, it's rare that anyone has made any money for the long term."
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No news there. Ben Graham, the father of value investing theory, said decades ago that airline stocks were bad news for investors. But human nature keeps people from listening. "Especially individual investors, they think they're good market timers," says George Athanassakos, director of the Ben Graham Centre for Value Investing at the University of Western Ontario. "They think they can hit the lowest and the highest, but that never happens."
The very volatility that makes the stocks risky also provide the exciting promise of profit. The potential opportunities are tangible, says Gordon Karels, college professor of banking at the University of Nebraska-Lincoln:
There is still option value as the company will continue to operate and look to cancel union contracts and lower operating costs. Since the stock sells for only $.20, a 10 cent move in the stock as a result of favorable news would be a 50% increase in your investment.Some might argue that the dour view only belongs to the giant airlines, and that smaller and more nimble competitors are safer bets. Maybe they are better at making a profit, but in terms of stock prices ... well, both JetBlue (JBLU) Southwest Airlines (LUV) stocks are down about 41 percent year over year. And conditions will only get tougher as fuel prices eventually rise.
It's getting better all the time
And with the bankruptcy of AMR, the industry is actually in much better shape than it's been for years, according to King. Consolidation has reduced the number of competitors. Excess capacity is gone. Airlines are avoiding financially marginal routes and keep prices to consumers up. Each bankruptcy has addressed union labor costs, and new planes with much higher fuel efficiency replace old ones.
"Right now, the airline stocks are off a lot in just the last quarter," King says. "But the airlines are doing much better. Demand remains strong."
Does that mean it's time to reconsider airline stocks? Wellll ... maybe not, according to San Diego State University finance lecturer Dr. Dan Seiver:
It doesn't take much of a shortfall in demand for them to hemorrhage money. They have helped themselves by getting their load factors way up, but my guess is that it won't last. If good times came, they'd buy more planes and fly more routes. They don't get religion for long.
Just about the time you think you're home free, things will turn upside down and you'll remember that airline stocks were born to break your heart -- and wallet.
