Yesterday Warren Buffett (Trades, Portfolio)’s investment company Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) reported its 2016 Q4 portfolio. The company revealed that during the last quarter Berkshire drastically increased its positions in airline stocks: Southwest Airlines (LUV, Financial), Delta Airlines (DAL, Financial), United Continental (UAL, Financial), and American Airlines (AAL, Financial).
Amid this news, the stocks of the airline stocks jumped with large trading volumes. A lot of investors are following Buffett into airline stocks.
Before buying into the stocks, I hope that investors realize that the valuations of the airline stocks are not cheap as they seem to be. Let’s take a look at Southwest Airlines, the most reputable company and the only airline company that has been profitable during last recessions. The P/E ratio of Southwest Airlines is currently 16.3, which seems to be at the lower end of the P/E of the stock over the last 10 years. Please see the chart below:
But if you take a look at the earnings of LUV, you may be surprised by how much the earnings have grown over the since 2014. The current earnings per share of LUV are about 7 times higher than they were in 2014. Please see the chart below.
But the revenue of LUV only increased by about 20% overall during the same period:
How can a 20% increase of revenue result in an earnings increase of 7-fold? It is the oil prices. Airlines have benefited tremendously from the lower oil prices during the last three years. Therefore its future earnings will also be dominated by the factors related to the prices of oil, which no one knows where to go.
For the cyclical businesses like airlines, P/S ratio gives a more accurate picture for valuation. Let’s take a look at the P/S ratio of LUV stock below:
We can see that currently the P/S ratio of LUV stock was at its highest point in more than 10 years. This is also the case for Delta Airlines:
And United Airlines:
American Airlines does not have 10-year history to show since its last bankruptcy.
We don’t why Warren Buffett (Trades, Portfolio) or his protégés bought the airline stocks at this point. Buffett has disdained airline industry many times in his shareholder letters, which we don’t want to repeat here. It is also unclear why they didn’t buy these stocks three years ago, when the stocks was more than four times cheaper.
But now, be aware, these airline stocks are at their highest valuations in ten years!
By the way, try our GURUF, the powerful Excel function for you to retrieve all financial data and create your research valuation charts in Excel.
