Investing in Airline Stocks

Airlines are an important part of the economy, but, for much of their history, the stocks have been lousy investments. Airline stock prices move with economic cycles, and past downturns caused airline bankruptcies and failures.

Industry consolidation has created a small group of competitors that are more effectively using technology to manage schedules and set fares. Today, four airlines control about 80% of the U.S. market.

Airlines after COVID-19

The COVID-19 pandemic temporarily caused airline revenues and share prices to fall in 2020. But vaccines have people on the go again, and airline stocks have regained altitude as passenger numbers have increased this year.

We’re still in the early days of the pandemic recovery, though, and passenger volumes are unlikely to return to pre-pandemic levels until 2024 at the earliest. Business travel and international flying -- the most lucrative for airlines -- are forecast to be the last to rebound.

Airlines have moved out of survival mode and are focused on recovery, but, given the damage done, it will likely take time for any of them to thrive or be able to pay a dividend again.

The best airline stocks

Airlines in the U.S. fall into three categories:

• Full-service companies, which fly globally, have different cabin classes, and serve many markets.
• Discounters, which offer few frills and service few destinations.
• Regional airlines, which provide small-jet service to secondary markets under the brands of full-service partners.

There are about a dozen publicly traded airlines in the U.S. Here are some of our top picks:

1. Delta Air Lines

This airline is the driving force behind much of the recent innovation in the industry. Delta Air Lines (NYSE:DAL) kicked off a round of consolidations that helped stabilize the business when it acquired Northwest Airlines in 2008, and, in the years since, it has revamped pricing to better compete with discounters. Delta even bought an oil refinery to help ensure its access to jet fuel supplies. Where Delta goes, its rivals follow.

2. American Airlines Group

American Airlines Group (NASDAQ:AAL) is a classic brand under new management and has been taking on more of a discounter mindset since its 2015 merger with US Airways. The airline operates a massive network and enjoys strong ties with important European partners. However, due to its legacy status, American Airlines could find it more difficult to shake off pandemic-related issues.

3. United Airlines Holdings

United Airlines Holdings (NASDAQ:UAL) has large operations catering to Silicon Valley and the U.S. energy sector, as well as a massive network throughout Asia. The highly cyclical nature of those markets mean that United's results can ebb and flow with tech or energy.

4. Southwest Airlines

Southwest Airlines (NYSE:LUV) is the original discounter, but today is one of the titans of the industry and no longer a maverick startup. The airline remains the only major carrier never to land in bankruptcy court, and its simplified operations have a track record of remaining profitable even when rivals struggle. Southwest has the industry’s best balance sheet and is an investor favorite for its ability to survive regardless of the challenges that come its way.

If you’re bullish on airlines but would rather not choose among individual stocks, lower-risk investments such as exchange-traded funds (ETFs) also cover the airline sector. The U.S. Global Jets ETF (NYSEMKT:JETS) is specifically focused on airlines, while the iShares Transportation Average ETF (NYSEMKT:IYT) and the SPDR S&P Transportation ETF (NYSEMKT:XTN) each allocate more than 25% of their holdings to airlines.

New competition is airborne

After a multiyear lull, we’ve seen two airline initial public offerings so far in 2021. Sun Country Airlines (NASDAQ:SNCY) and Frontier Group (NASDAQ:ULCC) have tapped the public markets for expansion capital.

Both are discounters focused on leisure travelers, who are expected to make up the bulk of demand in 2021. Investors should watch these companies closely as potential investments and to see how they impact their more established competitors.

Downturns tend to be good times for new airlines to emerge or for discounters to grow because airplanes tend to be available on the cheap. We’ll likely see more expansion in the airline sector and perhaps new entrants in the market.

Understanding the airline sector

Investors should understand several airline-specific terms before buying any stock. Here's what you need to know:

RASM

Short for revenue per available seat-mile, RASM is a measure of airline profitability. A company's seat-miles is the number of seats an airline has made available multiplied by the number of miles the airline's jets flew. Dividing revenue by seat-miles equals an airline's RASM.

RASM is important because all flights have different fare and cost structures depending on many variables, including flight distance and aircraft type. Simply looking at total revenue or expenses won’t give you the full picture.

An airline's RASM helps to indicate whether it is selling tickets at any price just to fill seats or if it has enough pricing power to sell seats for profit. Two different airlines could both have full airplanes, but, as an investor, you want to focus on the one able to do it with strong margins.

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CASM

Short for costs per available seat mile, CASM is an airline’s total costs divided by number of available seats, then multiplied by miles flown. It measures expenses the way RASM measures sales. If Foolish Airlines had total expenses of $24 billion during that year mentioned above, its CASM would be $0.12.

Load factor

Load factor measures how well an airline is filling its seats. For an individual flight, it is as simple as saying 60 of 79 seats were full. But for a major airline, that simple definition doesn’t tell the full story, because of differences in flight times. Airlines calculate their systemwide load factor by measuring how many seats were filled for each mile flown. Major airlines will provide this information on earnings releases and conference calls, but investors can calculate it at home by dividing revenue passenger miles -- as mentioned above, the number of passengers on a flight times the number of miles flown -- by the available seat miles.

Are airline stocks for you?

The airline industry remains cyclical, but the pandemic proved the companies are now strong enough to withstand tough operating conditions without having to fly into bankruptcy.

If you are bullish on long-term demand for travel, buying into a well-run airline is a way for your investment dollars to go along for the ride.