The Ups and Downs of Airline Stocks

by: Market Blog

There are three things you need to know about investing in airlines. These stocks are not for long-term investors, Warren Buffett won’t go near them, and short-term investors can make a killing on them if they’re nimble.

Airlines are not like most other businesses. They’re hobbled by stratospheric fixed costs in the form of pricey aircraft and their maintenance needs, along with extreme sensitivity to shifting economic conditions and energy costs.

While most stocks gyrate with their own uncertainties, they tend not to endure the same sort of busts that have come to define airline stocks – and not just in recent years.

“If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright,” Mr. Buffett said in a 2002 interview. “He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in.”

The 13-member NYSE Arca Airline index is a good proxy for what the global airline industry has done since 1992 – when the data start. If you had invested in this basket of stocks 18 years ago, you would have lost 17 per cent on your investment as of Friday. Needless to say, that compares unfavourably to the nearly 300-per-cent return for the S&P 500 over the same period (after dividends are included).

Meanwhile, some of the bumps along that downhill journey have been extreme. From 2007 until March, 2009 – a period that coincided with soaring crude oil prices and a crumbling economy – the airline index fell more than 80 per cent. After the Sept 11, 2001, terrorist attacks, the index plunged 46 per cent in just over one week.

Depressed? Most investors should be, and we haven’t even explored the relatively high risk of an airline seeking bankruptcy protection.

Still, foolhardy investors who can afford to put together the words “play” and “money” have good reason to stay interested in these stocks: When they take off, they really move. Since the S&P 500 touched bottom last March, the airline index has nearly tripled. UAL Corp. (UAUA) has done considerably better than the average, rising 420 per cent. There have been other, similarly rewarding bounces over the years.

Timing is the key issue here – and though not easy to pull off, it can be done. The trick is to take a contrarian approach to the economy and oil prices. When oil prices are stable and the economy is humming, bail out of airline stocks. But when oil prices are rising and the economy is disintegrating, hop on board.

In other words, while it might be tempting to join today’s rally in airline stocks as the global economy shows signs of improving, the better bet is to wait for the next downturn. Don’t worry. If history is any guide, it won’t take long.