Straightening Up and Flying Right

 | Feb 28, 2013 | 5:00 PM EST
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Warren Buffett once said that if a "farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville [Wright] down." He also quipped, "How do you become a millionaire? Make a billion dollars and then buy an airline."

Buffett's jibes are well targeted. The airline industry, at least since it was deregulated in the late 1970s, has not been known for its financial successes, but more for Chapter 11 bankruptcy filings and mega mergers. In mid-February, for instance, American Airlines parent AMR Corp. and U.S. Airways Group (LCC) announced they would merge, creating the nation's largest airline. To anyone who follows the airline industry, this was not a surprising move. American merged with TWA in 2001, Delta (DAL) merged with Northwest in 2008, United Continental (UAL) merged with Continental in 2012 and Southwest (LUV) bought AirTran Airways in 2010. And American's current bankruptcy proceeding is nothing unusual. Every major American airline except for Southwest has visited bankruptcy court at least once over the years -- and U.S. Airways has done it twice.

That's not to say all airlines are lousy investments. The American/U.S. Airways merger will likely strengthen the successor airline, even the entire industry. In fact, airlines have become profitable, and two of them earn high grades from my guru strategies. I modeled these strategies on the writings of Wall Street's greatest investors. Two airlines are flying high by the estimation of these strategies. They are worth paying attention to.

Southwest, long the industry's most solid performer, earns a high grade from my Peter Lynch-based strategy. This strategy focuses on the PEG ratio, which is price-to-earnings relative to growth and is a measure of how much the investor is paying for growth. The maximum PEG allowed is 1.0, and Southwest is flying well below the radar with a PEG of 0.79. In addition, the company carries a reasonable amount of debt.

The other guru-approved airline is Delta, which gets the nod from my James P. O'Shaughnessy-based strategy. This strategy wants a company with a sizable market cap, and Delta's is about $12 billion. This strategy also requires earnings per share to improve for each of the last five years, which is true of Delta, and its price-to-sales ratio should be below 1.5. Delta's is way below this threshold at 0.32. Finally, the strategy takes all stocks that pass the previous three variables and finds the top 50 based on their relative strength (which is a measure of how well a stock has performed in the past year relative to the market). Delta's relative strength of 87 places it in this top-50 cohort.

You don't have to be a pilot to know Southwest and Delta are flying straight and level. These are solid stocks for just about any portfolio.

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