Historically, the airline industry has been a terrible destination for investors. Over a 20-year period beginning in the early 1980s, U.S. airlines were involved in more than four dozen bankruptcies, with shareholders taking the financial hit on nearly every occasion.

But a lot has changed in recent years. The last round of restructurings completed in the late 2000s (and a series of acquisitions that followed) has created four strong companies that control nearly 80% of the domestic U.S. market and eliminated most of the irrational pricing that added to the volatility. Balance sheets are cleaner, labor contracts are more reasonable, and the prospect of major airlines flying through a recession is now brighter than ever.

Still, not all airlines are created equal. Here's a look at how to pick a good airline stock investment and three top choices for putting new money to work today.

An airplane taking off.

Image source: Getty Images.

How to pick winning stocks in the airline industry

Airlines like to talk about brand loyalty and the strength of their frequent-flier products, but for the most part, they are offering a commoditized product. Most consumers want to get from point A to point B as quickly as possible for the lowest price, regardless of the logo on the outside of the aircraft. Few airlines are able to charge a substantial premium to the competition on a particular route.

The airlines all operate fleets of similar Boeing (NYSE:BA) and Airbus jets, though the mix of planes in the inventory can make it easier for some airlines to match capacity to demand and make sure their flights are filled. Larger airlines, in theory, should enjoy some economies of scale on plane purchases and maintenance, but most of the bigger carriers also operate a more complex fleet with numerous different types of aircraft that negates much of that potential advantage.

There have been times when the aircraft you fly (or don't fly) can be a competitive advantage. For years, airlines that operated Boeing's 787 Dreamliner were able to price more aggressively than those that did not because of the plane's improved fuel economy. More recently, operators of Boeing's 737 MAX, which has been grounded for more than six months in 2019 due to software problems, have been at a competitive disadvantage to those who did not operate the plane.

Airplanes parked at the airport.

Image source: Getty Images.

When considering airlines, it is important to look at how they have positioned themselves in the market and what customers they are trying to serve. Full-service carriers Delta Air Lines, American Airlines Group, and United Airlines Holdings try to be all things to all people. They offer business travelers flying on short notice a multitude of daily flight options and access to the entire globe while still trying to serve more price-sensitive leisure customers.

Discounters, a group led by Southwest Airlines and including JetBlue Airways and Spirit Airlines, are more focused on low-cost flights and catering to vacationers, although many offer amenities and perks designed to attract business fliers. There are also a few hybrids like Alaska Air Group that offer full-service-like amenities but without the massive networks that the majors enjoy.

Airlines usually trade largely as a group, often tied to movements in oil prices since fuel costs are their single biggest expense. Overall, the best airline investments tend to be the companies that have strong management teams or a competitive niche advantage -- this is an industry in which winners tend to keep winning -- or those who have an opportunity to outperform relative to their peers due to some company-specific issues.

The top airline stocks

For years, airlines were viewed more as trading vehicles than long-term investments, with Wall Street pros buying into the industry as a recession fades and getting back out at the first sign of overall economic weakness. After a round of consolidation, and thanks to the healthier balance sheets of the survivors, airline stocks can now be held across the business cycle. But it is still wise to pick and choose carefully among the many options.

Here are three airlines that are set to outperform in the years to come, based on competitive advantages and current valuations. Even when buying the best companies, there is some risk to individual stock ownership, as even the best-run airline can be subject to a crippling labor dispute or fleet issues related to government regulation (like what is now going on with the 737 MAX). But buying and holding a basket of airline top performers can deliver solid long-term gains.

Top Airlines to Buy Now

Key Features

Delta Air Lines (NYSE:DAL)

Best-in-breed full-service airline, an innovator in the industry, high dividend, reasonable multiple

Alaska Air Group (NYSE:ALK)

One-time overachiever held back in recent years as it integrated a major acquisition. The integration is largely complete, and the airline looks set to take off.

Spirit Airlines (NYSE:SAVE)

A new generation of discounter with ultra-low fares and significant ancillary income. Seen as more vulnerable to a downturn and facing growing pains, but this is a good addition to a long-term portfolio for a risk-tolerant investor.

1. Delta Air Lines: A premium operator at a nonpremium price

Delta Air Lines has been the driving force behind much of the change in the U.S. aviation industry over the last decade or more. It was among the first to reorganize after the attacks of Sept. 11, 2001, and kicked off the round of consolidation that has created more stable balance sheets and a more investable sector when it acquired Northwest Airlines in 2008.

Internally, Delta was one of the first to revamp its pricing strategy to better compete with discounters that were eating into market share. It did this while still getting a premium price from less cost-focused customers. The company has also had some luck in 2019, as it has been able to take advantage of competitors like American Airlines and Southwest Airlines that were relying on Boeing's 737 MAX to help them grow capacity. (Delta does not fly the MAX.)

Delta A220 ribbon-cutting ceremony.

Image source: Delta Air Lines.

Full-service airlines like Delta compete, in part, by offering access to the entire globe. It can be expensive to fly to far-off destinations using only in-house planes, so the airlines rely on international alliances to expand their reach. But some international partners have proven to be troublesome in the past. At times, these partners have used their competitive-advantage access to certain overseas markets to extract more favorable terms from U.S. partners that need that access.

Delta's answer to the issue has been to use its restructured and fortified balance sheet to invest in international partners, locking them into the Delta system and occasionally even taking board seats to exert influence. For example, Delta was once seen as disadvantaged because it lacked a partner based in the U.K., and so it was somewhat cut off from the most lucrative transatlantic market. Its answer was to acquire a 49% stake in Virgin Atlantic.

The airline has taken a similar-sized stake in Aeromexico (vastly expanding its access to Mexico and Latin America), and it has smaller holdings in China Eastern Airlines and Gol Linhas Aereas Inteligentes of Brazil. Other airlines have followed the strategy and invested in partners, but no U.S. carrier has been as aggressive as Delta in growing its international holdings.

Delta was also a pioneer of the now-common industry practice of operating antitrust-immune joint ventures with international partners that allow them to coordinate schedules and seamlessly transfer passengers. Thanks to these alliances, Delta can offer customers in Los Angeles, for example, a variety of options when traveling to Paris, including some flights operated by partner Air France-KLM, without the expense of committing numerous airplanes to the route.

At times, Delta has veered far from the established playbook. Worried about a lack of available jet fuel for its hubs in the northeastern U.S., the airline bought a refinery in Pennsylvania in 2012 to try to ensure the supply to airports in the region.

The results speak for themselves. Delta has consistently produced quarterly results that are among the best in the sector, and it was the first of the restructured full-service airlines to introduce a dividend. In a "me too" industry in which competitors are constantly incorporating a top performer's best ideas, Delta has continued to innovate. It is currently in the process of rethinking its regional network in a bid to drive out complexity and improve results.

Some investors have voiced concern that Delta could be vulnerable in a broader economic downturn because the airline has grown more reliant on premium services, including business and first-class upgrades. Historically, Delta has generated upward of 70% of revenue from the main cabin, but lately that figure has dropped to about 50% as first- and business-class revenue has increased. During a recession, premium products are typically harder to sell, so there is a worry that in the event of a recession, Delta's revenue decline could be greater than the drop in overall demand for travel.

Delta is optimistic that technology improvements and policy changes that allow the airline to sell upgrades to individual flyers for cash or miles redemption -- instead of relying on corporate travel departments to green-light such perks -- will help cushion the blow. But investors should be watching closely to see how much of a hit the airline takes if and when a recession comes.

In Delta, investors can get the industry trendsetter, as well as the sector's best dividend yield, without having to pay a premium for the stock. Despite their track record, Delta shares consistently trade at a multiple-to-earnings ratio below that of Southwest and in line with those of its poorer-performing peers.

Investing in Delta offers the rare chance to buy into a proven winner without paying the premium commonly associated with top performers in mature industries.

2. Alaska Air Group: An airline stock ready for takeoff

For years, Alaska Air stood out as a reliable second-tier performer in a turbulent industry. It carved out a profitable niche in the U.S. Pacific Northwest and nurtured relationships with multiple larger airlines that succeeded in giving Alaska customers access to a broader route map and kept intense competition in its home markets to a minimum.

That model came under pressure as the larger airlines consolidated and began seeking turf for themselves, and in 2016, Alaska responded boldly with its acquisition of Virgin America. The deal was expensive -- Alaska had to outbid JetBlue Airways for the prize -- and saddled the company with $2 billion in debt and a difficult integration.

An Alaska Air 737.

Image source: Alaska Air Group.

Shares of Alaska have been underperformers since the merger, but the airline through it all has managed to retain the loyalty of its customers. And Alaska appears to be rethinking the national ambitions that came with the major acquisition and is returning to its West Coast roots. The company is shifting its capacity west, abandoning or scaling back some of the transcontinental flying to markets in which it has little or no presence while adding service to secondary regional airports including Redmond, Oregon, Everett, Washington, and San Luis Obispo, California.

The idea is to focus on flights that have a substantial customer base on both sides of the route at the expense of flights to places where it has little exposure or brand loyalty to help sell tickets. As part of the process, Alaska is also rolling out a fare system to rival those of Delta and the other large airlines. That means walking the fine line between competing on price and also extracting a premium from less price-sensitive travelers.

Alaska believes that by better selecting routes and competing on its own terms, it can consistently generate pre-tax margins of between 13% and 15%, nearly double what it generated following the merger. And the airline's dividend is second only to Delta's at the moment.

Alaska, throughout most of its history, has been an afterthought for most fliers outside the West Coast -- much to the chagrin of investors, who, over the years, have overlooked one of the top airline performers. After a rough patch, Alaska is back on the runway and ready for takeoff. The time is right to hop on board.

3. Spirit Airlines: The disruptive airline stock

The U.S. airline industry over the past two decades has been evolving away from an all-inclusive ticket and toward fewer frills and more itemized expenses. It's a strategy pioneered decades earlier by Southwest Airlines. Spirit Airlines is part of a new breed of carrier that goes a step further, bringing the "ultra-low-cost" model first made popular among European carriers to the U.S. market.

Spirit offers rock-bottom fares -- as low as $29 each way -- and then charges customers for a wide range of perks that used to be given away for free. The list of options a passenger can choose, for a fee, includes: bringing carry-on bags aboard, checking luggage, choosing a seat prior to check-in, and buying food and snacks. Spirit also charges more for bags and other items purchased on the day of the flight, encouraging passengers to buy early and giving the airline a chance to plan ahead.

A Spirit A319 at an airport.

Image source: Spirit Airlines.

Spirit's philosophy has made it the target of a lot of customer complaints, but the model has resonated with travelers who want affordable tickets and have no real need for add-ons. Spirit is still regarded as a "spill" carrier, which is an industry term that implies it only is able to fill its jets when its competitors have sold out. But the airline's load factors have steadily improved as it has grown and now are north of 84%.

Due to its position in the industry, Spirit is often considered to be among the most vulnerable to an economic downturn, and it has had its share of growing pains. The airline was plagued by a summer of cancellations and delays because the company was overly optimistic when eliminating some of the slack from its schedule. It was also hit by a construction project at the Fort Lauderdale, Florida, airport, a reminder of how vulnerable a smaller airline can be to a disruption in one key market.

Potential weakness in the U.S. consumer market for the remainder of 2019 could further cut into results and put Spirit's aggressive growth plans at risk. But the airline, despite its relative youth and more cost-conscious model, should have plenty of fuel to power through a recession. Over time, it offers much better potential for growth than its blue-blood competitors.

Spirit looks like a long-term winner, but this is an airline stock best held by investors who aren't afraid to ride through some turbulence.

A word of caution about airline stocks

As mentioned above, no airline (no matter how well run) is immune to spikes in oil prices or economic softening that eats into demand. Recessions happen for different reasons, and it's hard to address every potential vulnerability to outside economic forces. For example, an economic slowdown outside the U.S. could hurt the full-service carriers more than the discounters.

With the seemingly ever-present talk of global trade tensions and the on-again, off-again threats of sanctions against Iran or other dangers in the Middle East imperiling oil supplies, the airline sector is likely to see some volatility in the years to come. Throw in a potential slowdown in the U.S. economy, and airline earnings estimates are at risk to come crashing down.

The airline industry believes it has finally consolidated to a point that investors no longer have to worry about a flurry of bankruptcy filings that wipe out equity holders every time the economy goes south. Balance sheets are healthier, and increasingly, a large percentage of airplanes are now leased instead of purchased outright to help keep debt levels reasonable.

I believe in the transformation and believe investors can finally apply a traditional buy-and-hold philosophy to the airline industry. But pick your winners carefully, and be prepared to hold for the long term.

The industry has come a long way, but at 35,000 feet, it can get harder to predict when you'll hit a rough patch of air. It's safe to climb on board these airline stocks, but leave your seat belt fastened while in flight.