The Next 5 Stocks to Buy?

Airlines have been notoriously lousy investments over the long run. The economics of the business haven't been favorable for a long, long time. Even Warren Buffett, who ended up making some money on his USAir gamble in the 1990s -- after trying to unload the stock for pennies on the dollar -- has since quipped that he has an 800 number to call to talk him down should he ever consider buying an airline stock again. Recently, some airlines have been pushed to the brink of bankruptcy protection by soaring oil prices, and only with the ensuing tumble in commodities have their shares rebounded.

The economics don't get better for regional airlines, either, particularly when their major carrier forces them into an untenable position. Just ask Pinnacle Airlines (Nasdaq: PNCL  ) , which services both Delta Air Lines (NYSE: DAL  ) and Northwest Airlines (NYSE: NWA  ) . Delta claimed Pinnacle's on-time performance was lousy and wanted out of its contract. Delta canceled its contract with ExpressJet, and Mesa Air had to get a court injunction to stop Delta from severing their relationship. For its part, Pinnacle said it was Delta that set the routes, even though Pinnacle had expressed concern that they were unworkable. Now that those concerns have been justified, Delta's blaming Pinnacle for them.

Screening for likability
So with all the drama, why would anyone want to invest in Pinnacle, which showed up on a screen of companies that have enjoyed growing investor support these days after wallowing on the outs three months ago? Pinnacle jumped from a two-star Motley Fool CAPS rating back in May to a three-star rating today, while also enjoying a valuation below that of the market.

First, Pinnacle and Delta have since made up, and the contract between the two will continue. Pinnacle will delay delivery on some of its aircraft until 2009 and incur $2 million in costs over the third and fourth quarters. Everything else about their contract remains unchanged. Second, this will provide a level of stability for Pinnacle's revenue, and once Delta and Northwest finally merge, Pinnacle will be dealing with a more financially stable airline. Moreover, it removes uncertainty about what would happen to the Northwest contract once the two joined forces.

Before he began unloading his own shares this year, Buffett follower Mohnish Pabrai had said that the industry was evolving away from the hub-and-spokes setup to more nonstop flights. Jumping directly from small city to small city isn't desirable when using larger aircraft, so demand for a regional airline's smaller fleet would be driven higher.

Lastly, Pinnacle remains profitable after special charges. It reported second-quarter earnings of $5.4 million, or $0.30 per share. Profits were affected by higher oil costs and performance penalties with Northwest, but those were primarily weather-related and beyond its control. Pinnacle also took a charge on $136 million locked up in auction rate securities.

A stable operating environment, a steady stream of revenue, partners that should be stronger, and a growing demand for services seem to make Pinnacle the apex of opportunity.

Put your thinking CAPS on
CAPS is a community of more than 115,000 members who rate thousands of stocks on whether they will outperform or underperform the market. While it's not a predictive service, our data has shown that the returns of stocks in the CAPS universe correlated precisely with their relative CAPS ranking. Three-, four-, and five-star stocks significantly outperformed low-rated one- and two-star stocks.

Here are a few of the other companies the CAPS screener found that are enjoying significant investor support:

Company

CAPS Rating May

CAPS Rating Today

P/E

PEG*

ProLogis (NYSE: PLD  )

**

***

15.2

1.9

Whirlpool (NYSE: WHR  )

**

***

11.4

0.9

Pinnacle Airlines

**

***

13.4

0.2

Cadence Design Systems (Nasdaq: CDNS  )

**

***

12.4

12.2

Reliant Energy (NYSE: RRI  )

**

***

5.5

0.5

Source: Motley Fool CAPS; Yahoo Finance, Morningstar.

*For next fiscal year.

Naturally, this is not a list of stocks to buy and sell, but rather a starting point for further analysis. Investors have raised their outlook significantly on these companies, and long-term outperformance is best achieved by investing in growing, well-run companies that consistently increase shareholder value.

A fine mesh filter
Obviously, there's still a bit of risk factored into Pinnacle's share price. In March, CAPS member kreed01 wrote that investing here would bring much of the upside potential, without all the potential downside.

The benefits of airline growth without airline risk. They provide regional jet service to major airlines like Northwest and Continental. The majors bear the risk of fuel costs, passenger loads, etc. They just got new fuel efficient planes. Well positioned to grow over the next few years. Plus Pabrai Funds (the famous Warren [Buffett] clone) owns 15% or so.

While we know now that there were risks in the contracts, those have been settled for the time being. Also, while Pabrai has reduced his holdings in Pinnacle, he is still a stakeholder in the airline he identified earlier this year as one of his best airline picks.

Take a CAPS bow
There are many ways to screen for stocks to beat the market. You can use the new CAPS screener to find other stocks you may want to own and then start your own research on them at Motley Fool CAPS. Read a company's financial reports, scrutinize key data and charts, and examine the comments your fellow investors have made -- all from a stock's CAPS page. If you want to see what the best in CAPS are saying now about Pinnacle, head over now.

Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 18, 2008, at 11:23 PM, djepayne wrote:

    Two weeks ago CDNS stock dropped over 30% in a single day after they announced lower earnings and reveneus.

    Buyer beware.

  • Report this Comment On October 26, 2008, at 12:29 AM, StocksBuyorSell wrote:

    I would avoid all these companies like a heart attack.. There are much better investment opportunities available, and prices are coming down into buying range.

    http://stocksbuyorsell.com

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