Using Ratios To Identify Stocks Set To Outperform Their Peers: Airlines Ranking Update

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Includes: AAL, ALK, DAL, LUV, UAL
by: Stock Scrutiny
Summary

Adding another year of the airline industry to my research project.

Included are the stocks' rankings in debt, profitability, efficiency, and growth categories along with multi-year trends.

Weighting of each category is presented as well as adjusting for buyback rates.

Introduction

My next article in this series looks to add another year of the airline industry to my research. Any new readers that wish to see a detailed explanation on how I arrive at these results, please see my introductory article that elaborates on my process. As a quick summary, I believe that over the long run, stocks that rank higher than their competitors financially (according to my assortment of ratios) will outperform stocks that have a lower ranking in that same industry. Ratios have their shortcomings, but if utilized properly, they can be helpful in analyzing a company's current financial position.

Included in this analysis are Delta (DAL), Southwest (LUV), United Continental (UAL), American (AAL), and Alaska Air (ALK). Pricing data is gathered from Nasdaq, while scores were calculated using financial statements from E-Trade.

Ratio Research

Debt

Company Name Total Debt/Total Equity Quick Ratio Current Ratio Defense Interval Current Liquidity Ratio EBIT/Interest Expense
Delta Air Lines 117.3% 0.29 0.34 18.7 872.3 21.01
United Airlines Holdings 195.6% 0.49 0.55 40.1 546.9 5.56
American Airlines Group 100000% 0.40 0.49 53.5 1,361.9 3.20
Southwest Airlines 47.8% 0.57 0.63 84.5 314.5 34.93
Alaska Air Group 98.3% 0.57 0.59 68.0 521.1 8.27

Current Debt Scores

1. Southwest - 1

2. Alaska Air - 2

3. United - 3.5

4. Delta - 4

5. American - 4.33

Progression Since Last Year

Profitability

EBIT Margin Gross Margin Net Margin Return on Assets Net Income per Employee Effective Tax Rate
Delta Air Lines 12.8% 20.8% 9.9% 7.7% 44,213.5 23.6
United Airlines Holdings 9.9% 13.8% 6.2% 5.5% 23,141.3 19.9
American Airlines Group 7.6% 24.4% 3.3% 2.6% 10,954.2 25.1
Southwest Airlines 14.0% 27.4% 10.8% 9.2% 41,921.8 22.1
Alaska Air Group 8.9% 19.6% 5.3% 3.7% 18,694.4 25.3

Current Profitability Scores

1. Southwest - 1.33

2. Delta - 2.17

3. United - 3

4. Alaska Air - 4.17

5. American - 4.33

Progression Since Last Year

Efficiency

Sales per Employee Return on Equity Capital Expenditure Ratio Employee Cost Per Unit of Revenue Total Asset Turnover Return on Invested Capital
Delta Air Lines 0.50 33.8% 8.60 0.31 0.77 18.7%
United Airlines Holdings 0.45 27.9% 9.89 0.33 0.88 10.4%
American Airlines Group 0.35 0% 11.89 0.35 0.79 6.0%
Southwest Airlines 0.37 24.6% 11.12 0.48 0.85 18.1%
Alaska Air Group 0.35 12.2% 8.61 0.32 0.71 7.1%

Current Efficiency Scores

1. Delta - 2.17

2. United - 2.33

3. Southwest - 2.83

4. American - 3.67

5. Alaska Air - 3.83

Progression Since Last Year

Growth

Free Cash Flow Growth Revenue Growth Total Debt Growth EPS Growth Change in Working Capital Growth
Delta Air Lines -62.9 9.7 98.4 0.7 -86.8
United Airlines Holdings -38.2 9.1 25.2 -60.5 188
American Airlines Group -316.3 8.7 64.0 -72.6 -204.3
Southwest Airlines 166.4 10.8 2.5 31.2 2,373.7
Alaska Air Group -68.8 47.6 207.9 -46.2 -50.1

Current Growth Scores

1. Southwest - 1.2

2. United - 2.8

3. Delta - 3.2

3. Alaska Air - 3.2

5. American - 4.6

Progression Since Last Year

Weighting

After implementing performance-based weighting to each category, I have determined that the profitability ratios are most correlated to price performance, followed by efficiency, growth, and debt. Therefore, instead of the equation for finding the cumulative score of a stock looking like this:

(Debt Score x .25) + (Profitability Score x .25) + (Efficiency Score x .25) + (Growth Score x .25) = Final Score

...it now looks like this:

(Debt Score x .21) + (Profitability Score x .29) + (Efficiency Score x .27) + (Growth Score x .23) = Final Score

With this weighting, more value is given to categories with the greatest correlation to price performance, which, in turn, should lead to more accurate final scores. To answer any lingering questions about how I determine weighting, please see my article that introduces the concept. Here are the most recent weight-adjusted scores for the airline industry:

1. Southwest - 1.64

2. Delta - 2.79

3. United - 2.88

4. Alaska Air - 3.40

5. American - 4.21

Adjusting For Share Buybacks

In one of my articles, I introduced how share repurchases can influence share price, and thus, why my future analyses will attempt to account for companies' strategies in this area. For more details on how I determine these upcoming weights, please see the article that explains its implementation. In short, I standardize each company's rate of common shares' outstanding reduction to have an effect of between -.1 and .1, with the stock that retires the greatest percentage of its shares to receive the .1 improvement in its score and so on. Here is a table showing the data:

Share Repurchase Rate Effect on Score
Delta Air Lines 3.9 -0.025806452
United Airlines Holdings 5.9 -0.090322581
American Airlines Group 3.1 0
Southwest Airlines 6.1 -0.1
Alaska Air Group -0.1 0.1

Complete Scores

1. Southwest - 1.54

2. Delta - 2.76

3. United - 2.79

4. Alaska Air - 3.50

5. American - 4.21

Progression Since Last Year

Southwest retained its dominance among all companies and even gained some ground against the other airlines. The improvement in the stock's score was largely due to the significant jump in its growth score from 2.4 to 1.2. At the outset of my research, this was the kind of company I set out to find in terms of financial strength. Of course, one can't ignore the impact from grounding the Boeing (BA) 737 MAX's on Southwest's current financial state. However, since my project does not account for day to day developments in the investing world, we'll just have to see how those groundings affect next year's score along with other companies as well.

Improving a place was Delta, pushing past United into the second spot. It will be interesting to see if the stock can maintain a score under 3, and, in other words, have above-average financial strength relative to the other airlines. I currently have a position in Delta, and I'm happy enough with the improvement in its score to keep it over swapping with Southwest - especially when accounting for other factors not captured in this type of quantitative analysis.

United finished at basically the same score as it did a year ago, but due to Delta moving around, among others, finds itself in third place instead of second. That being said, the stock has shown 2 straight years of better-than-average scores. So, in a strictly financial sense, it looks like an attractive opportunity. There's a pretty large gap between the first and second half of the list, with Alaska Air scoring fourth place. Despite remaining constant in that respect, the stock's score actually worsened since last year. Later articles will address altering scores and their effect on price appreciation, but the theory lies that worsening scores lead to lower than average returns, especially in comparison to improving scores. Finally, with two straight years of lagging performance, American Airlines is placed fifth. Not many positives can be drawn from any category or trend, as the company took last in almost every single category and found a way to make its already bad score worse. Putting all of that together doesn't seem very promising for the stock.

Conclusion

Ratios certainly aren't the be-all and end-all, but I'm a firm believer this type of strategy can serve as a useful supplement for investors conducting a holistic analysis. This is the second year I ranked the airline industry, so the scores can be looked at on a multi-year basis.

Feel free to leave any feedback or suggestions in the comment section, and if you wish to see future articles ranking different industries as well as statistical breakdowns of historical scores and their relation to price, click the orange follow button at the top of the page.

Also, readers are welcome to suggest industries for me to add to my research. Any suggestions will be put into a written article within the next couple of weeks!

Disclosure: I am/we are long DAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.