Warren Buffett doesn’t dump his positions very often, so when he gets rid of all of his airline stocks, because he thinks they are just that bad, this is going to alarm some people.
Warren Buffet once swore he’d never own an airline stock again. Back in 2007, he told investors that “if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”
This is perhaps as bitter of a view of the airline industry as could be imagined, and Buffett did get burned by an airline deal gone bad when he took such a beating with his U.S. Air acquisition. The concept of never saying never applies to even one so staunch as Buffett, even one this angry and disenchanted, and in 2016, he decided to pour more money into this bottomless pit, throwing the dice again hoping for a better roll this time.
Buffett bases his investing decisions on company fundamentals, and does so entirely, and among his sayings are buy the company not the stock. He managed to bury the hatchet and sit down at the airline table again with enough chips to buy a full 10% of each of the four major airlines in the U.S., United, Delta, Southwest, and American. Owning that much of the airline business and spreading around like this wasn’t a stock play, it was a sector play of course.
While these airline stocks ended up being shot out of the sky by fears of COVID-19, we don’t want to just want to write this mistake to fate, even though what has happened to airline stocks since was more than enough to have this usually confident and sometimes stubborn legendary investor to put on his parachute and jump clear away from these stocks as he just did.
There is so much concern with airline stocks right now that even Warren can no longer make sense of staying, and when an investor this dedicated to staying the course no longer can do so, that in itself speaks volumes to how dim the outlook is. We only wonder why it took him this long.
His now saying that the airline industry has been “really hurt by a forced shutdown,” although this is not a conclusion that he should be coming to in May, as this should have been painfully obvious enough when the shutdown began, when the airline industry itself was first placed in quarantine.
Not surprisingly, investors took Buffett’s lead and drove the price of airline stocks further down on Monday, even though the level of the ocean being raised by a late day market rally reduced the toll somewhat. They should be painting bears on all those planes who are parked right now, but they will not remain parked forever, and this is important to bear in mind as we look a little forward.
Buffett is plenty upset about how this all played out, and he admits that he made a mistake with this, but also does blame the coronavirus. The period between when this virus hit and when you could have gotten out is the part that the virus is responsible for, while the period between then and when he actually did jump out of this plane is on you.
While Buffett cannot just click his mouse and be out of these huge positions like we can, and it takes time to divest this much stock, it’s been almost 3 months now since we first knew how bad this would probably be, and it doesn’t take that long to exit, especially with the sense of urgency involved. Sure, you will take a hit on this, but whenever you are selling into a panic, this is no time to play around too much because this will just make your losses bigger, not smaller.
It’s nice to have the luxury of waiting for demand to pick up more, selling into more strength, but with the big moves, you may not have this luxury. With the outlook on airlines certainly remaining atrocious for a while, it wasn’t that this was coming anytime soon. The length of time it took Buffett to get out of these airline stocks can only be explained by way of a lack of decisiveness, although thankfully for him and his shareholders, he eventually was able to bring himself to act.
We want to go back further than this though to see what we can learn from this mistake, and the real mistake was made back in 2016 when he started to build his positions in these stocks. While we have the benefit of looking at the charts, Buffett doesn’t care much about them, and his big mistake was on the fundamental side actually.
The first half of 2017 was a pretty good period for airline stocks, and for a time he would have been probably happy he changed his mind about this sector, if that was what he was focused on, but he instead focuses on the longer-term and the fundamentals.
We can get a good view of how these stocks have moved over the last few years by looking at the U.S. Global Jets ETF (JETS), which tracks the four major airlines that Buffett held. Since mid-2017, it’s just been trading in a range, in a way that has lagged the market, but we don’t want to hold this against Buffett since he focuses on a bigger picture than this one told.
The mistake here is claiming to be focused upon the future but instead focusing on more present business conditions, the ones that you deal with when you perform classical fundamental analysis. Buffett no doubt spent a lot of time looking at the numbers, and he obviously liked what he saw, but should have focused more of his attention on the prospects of the sector further out than this.
This is an easy mistake to make and is made all the time by those who look to understand stocks this way, and all the time really means all the time. The big reason behind this is that these analysts think stocks grow by themselves, where treading water will somehow power you down the pool.
Standing Still Gets You Passed
Let’s imagine that we buy stock in a company that has great earnings and these earnings grow nicely with the rate of inflation, creating at least the illusion of growth even though they are stagnant. Perhaps they beat inflation by a little bit and we can then claim that they do have net growth and not just nominal growth, and this makes us even happier. We own a piece of this revenue flow and it gets a little bigger each year, the industry and the numbers are solid, and we look forward to taking advantage of this for years.
This seems sensible enough if that’s the way things actually worked. We can look at the earnings of the sector over the period that Buffett was in it, and while these things do ebb and flow, they were quite stable and were projected to remain so in the foreseeable future, until the coronavirus hit that is.
You might think that this would make it a pretty good stock to own, especially when you consider that a lot of businesses are shrinking, the auto sector or the retail sector for example. This may be enough to keep the stock from going down, as long as the view that the market has towards the sector does not in itself dim, but this is not a game of not losing money on our stocks, we want to make money, we want to see them grow. Stocks grow in value when their prospects improve or are seen to improve, not by just making the same old money or close to it.
The easiest way to explain the mistake that Buffett made with these stocks is to go back in time a little bit to when he started to accumulate them, buying the whole sector basically, and then ask what the chances are of the industry growing all that much versus other industries like tech and health care.
We’re spending a lot more money every year on both of these other sectors, but just how many more flights can people possibly take? How much more could the industry possibly grow, not just over the next few years but even further out than that? People buy more and more tech, and spend more and more on health care because people are getting sicker and sicker, but the demand for air travel is already very well saturated, and this matters a great deal to the prospects of the stocks in the sector.
The range that we spoke of is the sector in a holding pattern, just waiting for some sort of economic contraction to take some of the air from their wings, and then there’s nowhere else to go but down. All stocks bear this risk to a certain degree, but those in holding patterns like this sector can’t grow much more, because demand can’t grow that much more, but it sure can shrink when the skies are not so clear anymore.
This is what we really need to pay attention to if we are looking to do fundamental analysis, to look at how demand is projected to change over the longer term if we want to invest in that longer term. Within a sector, you might see one company gain a competitive advantage over another, and while the sector may not be growing that much you may get a bigger piece of the pie and grow that way, but this does not work when you buy the whole pie like Buffett did.
We always want to be looking to the future when we assess a company’s growth prospects, as there are two ways to grow, by getting a bigger piece or the pie growing larger over time, and we need the growth that we are hoping for to come from somewhere.
With stocks, companies that issue them either grow enough or are left behind, and the money that people put into stocks and take out of them are also valued relative to one another. If another company in a different sector, like Amazon for instance, is growing a lot more than you are, this will cause money to either flow into their stock instead, limiting the growth of your stock price, or even flow out of your stock into theirs.
The airline sector isn’t a bottomless pit, it’s actually a pit that we have already found the bottom with and have already filled it up close to as full as it may ever become. It might be only half full, but we need to have the ability to fill it a lot more if we want to be watching its level grow and not remain stagnant or even recede.
Maybe we’ll one day come up with technical revolutions that will significantly improve efficiency, but those improvements will just get passed on, and the real problem here is that we need more bodies to fly around to do much expansion. Not thinking this through properly was Buffett’s biggest mistake here and would have avoided all of the losses he suffered as a result.
Buffett’s Loss May Be Our Gain
Airline stocks have of course become very oversold now, but even so, we need to wait for the right time to jump back in, and that time is not now to be sure. We do feel that there will be some real opportunities here at some point though, and probably sooner than a lot of people think, those who see the sector suffering for a few years from this.
This is another example of why it is so important for investors to have as good of a grip on the health scare as they can get, and why we have spent so much time talking about it over the last while even though we are a financial site. As spooked as people are now about flying, it is not that we are doomed for years from this, even though many people do tend to not be all that rational, especially when it comes to flying.
For instance, it took quite a while for some people to become comfortable with flying after 9/11, which materially influenced the balance sheets, even though the risk of a particular flight being hijacked even without the extreme security changes that this caused is so close to zero that it makes no sense to ever worry about such a thing, no more than worrying about being shot in the street randomly.
The chances of your plane crashing are actually a lot higher, when we compare the number of deaths from hijacking with deaths from natural crashes, and the chance of dying in a plane crash is much lower than with ground transportation, but fear by its nature subverts reason and does so quite successfully with many of us.
We can be sure that there will be some who may not only be afraid of flying even with separation, flying planes half full at most and taking other measures to protect passengers against the coronavirus, even long after it is gone.
There are folks, and quite a few of them, who think that social distancing will be a long-term need or will even make sense to continue when this risk fades off into the sunset, but it is almost impossible to consider the need for all that many people worrying about a virus that is no longer around in numbers that matter.
Unless we decide that we want to declare war against all infectious disease, the cold, the flu, and other common ones to the point where we social distance forever, if the reason why we are doing this is actually from fear of COVID-19, this will die off with the outbreak.
While the outlook for airlines isn’t anything that we would normally should want to touch, as there are so many other stocks out there with more promise, this setback is only a temporary one at these dire levels anyway, and making back a good part of what has been lost this year with these stocks has this going from grim may actually be pretty exciting return wise.
Long term, airline stocks are just as mundane as ever, but after getting knocked down on their behinds, just getting back to their feet will have them not perhaps as tall as other sectors but a lot taller than they are down on their knees like this.
We can understand Warren Buffett bailing here, even though we may already have put a bottom in and it’s not easy to imagine how things could be much worse than right now. With the virus starting to move toward the door and our economy at least moving to one knee now, we may wonder whether Buffett didn’t buy at the top and sell at the bottom.
The time to get out of these stocks if you were going to was back in February, not March, April, or May. We’re still a good way off from even half capacity, being at only 5% now, but going from 5 to 50 surely will heal at least some of the 60% that we’ve given back since February with these stocks overall.
Buffett only goes all in, he’s either bullish long term or he does not want to play, so in light of this, it may be better that he did get out now rather than wait for this recovery and at least trim some of the $4 billon he booked as his losses on these positions. They certainly aren’t good enough to remain a millstone around our necks for years whether we get back to normal or not, but there is a time and place for everything they say.
These stocks bear watching and when the smoke from this crash clears enough for these stocks to be seen as a bargain and as a rebound play, Buffett’s losses might be able to be turned into our gain, if we wait until the party starts and be sure to leave when it ends. As bad as this all is for the airlines, this industry isn’t going away, and neither will their stock prices stay this oversold for that long.
When a stock’s price crashes, that means that it has been overly devalued, not unlike pushing something that floats beneath the water. The hand that is keeping it down does tire eventually, as it has with the market overall, and those who missed the general rebound may still find opportunity with the stocks that are still being held down so hard, but only when the time is right.
Even with bottomless pits, timing is everything.