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Valuing companies is a challenging endeavor, so sometimes a quantitative method or model can help provide some perspective on an industry. Because I feel riskier stocks should be given worse valuation, and that the market often does not respect this fact of life for brief periods of time, I have created a valuation of the airline industry below which accounts for both risk and fundamental value.

It uses the price to sales ratio and the price to cash flow ratio from each company in the industry and averages the two. Then I take the reciprocal to create a measure of fundamental value of the company, similar to an earnings yield. I prefer this method to an earnings yield, though, because earnings are often manipulated easily through asset sales and the like.

For the final step, I calculate a weekly one-year beta on each company and divide by the index created. This equals the alpha score, and it is based on fairly recent history. The lower the alpha, the more value you get for each unit of risk.

Stock Beta Alpha Score Index AVG P/S P/CF
Delta (NYSE:DAL) 0.96 2.2 0.43 2.3 0.3 4.3
AMR 1.38 2.8 0.50 2 0.1 3.9
Alaska Air (NYSE:ALK) 1.25 3.5 0.36 2.8 0.6 5
Chinese Eastern (NYSE:CEA) 1.26 3.6 0.35 2.85 0.6 5.1
China Southern (NYSE:ZNH) 1.52 4.0 0.38 2.6 0.4 4.8
Ryanair (NASDAQ:RYAAY) 0.78 4.8 0.16 6.15 1.9 10.4
Southwest (NYSE:LUV) 1.04 4.9 0.21 4.7 0.8 8.6
TAM 1.21 5.0 0.24 4.15 0.6 7.7
United Continental (NYSE:UAL) 1.66 5.5 0.30 3.3 0.4 6.2
LAN Airlines (NYSE:LFL) 0.62 5.5 0.11 8.9 2.4 15.4
GOL Linhas (NYSE:GOL) 1.2 6.4 0.19 5.35 1 9.7
Copa Holdings (NYSE:CPA) 1.2 7.5 0.16 6.25 1.9 10.6

The results show that DAL and AMR are strong buys, while GOL and CPA are strong sells, all in a relative sense. In an absolute sense, these companies might actually all be extremely overvalued or extremely undervalued, but that is not what this study is for. This study is for those interested in relative to industry terms only.

One might want to do more due diligence with each firm before actually investing based on this model to fully understand the risks inherent with each company. This model is intended to help guide investors in stocks in the airline industry when investors cannot decide what to do with positions they already have.

One idea would be, if you are holding a weak company which has a sell recommendation, you might want to sell it, even if at a loss, and replace it with a "buy" recommendation company to maintain your exposure to the airline industry, just with model-demonstrated better value. That way your risk is limited on the model's recommendation.

This model is totally unbiased, as I have no positions in any of these companies.

The bottom line is I like companies which are low risk and with high value, and I think the market should too.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Valuing Risk and Fundamentals in the Airline Industry