Why I Bought Southwest Airlines (LUV) Instead of American Airlines (AAL) This Time and Didn’t Before

I can’t believe it’s already been over 7 years but that was the last time I started to invest in airline stocks and found myself deciding between Southwest Airlines (LUV) and American Airlines (AAL).

At the time, back in 2014, the nation was in the midst of another public health scare in the form of the Ebola outbreak originating from West Africa.

I closely followed the news coverage. The interviews I saw with scientists and government representatives made it clear to me that the risk to the country was minimal.

And yet, the stock market was quick to punish the stocks of major airlines, fearing there’d be a significant downturn in domestic and global travel. Even if investors didn’t believe Ebola was a serious risk to public health, the public hysteria had to be taken seriously at least in the short term.

I remember when airline stocks took a huge hit after a nurse was found to have been infected with the virus here in the U.S. That was also the first time when I realized it could be a buying opportunity. However, I still needed to research the industry more closely.

The airline industry had come to be afflicted with a negative reputation in the stock market. When airlines were deregulated in 1978, competition increased tremendously and profitability plummeted.

There was a time when airlines competed primarily based on service (at one point every seat felt like first class) but with deregulation and new companies entering the industry the focus shifted to price competition. Low prices also seemed more important to passengers, especially non-business customers.

Price competition in the airline could be fairly described as cutthroat. New entrants continued to appear because the market opportunity seemed attractive and ripe for gains. This also backfired as a number of airlines went out of business. World-famous airlines succumbed to bankruptcy and disappeared. Others like TWA got taken over by more successful airlines. At the same time, passenger fares dropped and margins continued to shrink.

At various times, the low prices of airline stocks looked like great buying opportunities for value investors but the truth is they were more akin to falling knives. Even the famous investor Warren Buffett soured on the industry in the 1980s and vowed to never buy airline stocks again.

Years later, in 2016, Buffett had a change of heart and bought airlines again. He eventually sold them all off in April 2020, but we can chalk that up to the volatility of the global pandemic. More importantly, Buffett reinvested in airline stock for some of the same reasons why I was attracted to them in 2014.

In particular, Buffet cited consolidation in the industry as a positive difference. After years of extreme competition, the U.S. airline industry was left with four major players: American Airlines, Delta Airlines, United Airlines and Southwest Airlines. This level of concentration made it more like an oligopoly and reduced pressure to lower prices.

The relatively higher level of concentration was an aspect of the airline industry that was also reported widely in 2014 and certainly on my mind when I considered making my first investment in airline shares.

Another thing that struck me was that we were also in a period when oil prices were declining and were widely expected to continue to do so as a result of the fracking revolution and corresponding supply surplus. In other words, airlines stood to benefit from lower energy costs.

When I compared the major airline stocks, American Airlines seemed especially attractive to me. Southwest Airlines was long favored by airline investors because it was more profitable to run but it didn’t seem as good of a value. I felt there were too many Southwest fanboys who had chased up its stock price.

Notably, Southwest Airlines secured a significant percentage of its fuel supply via long-term hedging deals. Of course, it also had to pay a premium for this benefit. American Airlines, on the other hand, was widely known for not engaging in any hedging. The way I saw it, it would also be able to take advantage of lower fuel costs in the future. Thus I settled on buying American Airlines.

I was ready to pull the trigger but felt a bit of regret for not buying sooner. Airline stocks had already started to recover. I was reflecting on what to do next, whether I should go ahead and buy now or wait for another opportunity. Ironically, that opportunity came sooner than expected. I was in my car driving to a conference in Los Angeles and listening to the radio when I heard the news of another American nurse infected with Ebola. Even worse, this nurse had traveled on an airplane and possibly infected other passengers.

I immediately took the next freeway exit and pulled over to a parking lot. Of all places, it was a hospital parking lot. I took out my phone and checked the stock market. Sure enough, airline stocks were getting pummeled. In that moment, I bought over $30k worth of AAL stock, the single largest stock purchase I had ever made up to that point.

I held onto my shares for a few months and ended up selling for over $15k in profits. Needless to say, I felt ecstatic and immensely proud of myself.

Fast-forward to March 2020 and it seemed like deja vu at least initially. Once again I felt drawn to airline stocks but the news coverage was decidedly more critical. The fact that Italy, a major Western European economy, was implementing lock-downs was giving me pause. I bought airline stocks but also sold them quickly, at a slight loss but nowhere near as much as what I would have lost had I held onto them.

That being said, I still kept an eye on airline stocks (as well as other potential reopening stocks) and expected to buy them again as we moved closer to a pandemic exit. That moment arrived with the announcement of the first vaccines at the end of 2020.

This time I decided to be more cautious. Instead of selecting American Airlines, I opted for Southwest Airlines. I felt Southwest had a better risk profile. It didn’t have the same issues with debt and seemed well managed. Importantly, it was more of a domestic U.S. airline and wasn’t reliant on international tourism and business travel like the three other major airlines.

I’ve held onto LUV stock ever since and I’m confident it will make it through the current downturn just fine. Under the current circumstances, Southwest Airlines is a forever stock.

I believe Southwest is well positioned to see past temporary obstacles like new variants and I’m excited to see what the future holds for it.