I’ve had friends, family, and clients inquire about buying specific companies and sectors after the massive drawdowns due to COVID-19. The theme seems to be airlines, cruise lines, and casinos. Three of the biggest airlines are down between 50 and 60 percent YTD. The three largest cruise lines are down between 65 and 80 percent. Big-named casinos are down anywhere from 40 to 60 percent.
Post social distancing, we all envision a world where we are traveling, vacationing, and spending some time at the blackjack tables. So, the question becomes, is it time to buy airlines, cruise lines, and casinos?
“They will get back to where they once were”
This is the most echoed statement I’ve heard about these three industries. But I also heard the same statements about General Electric (GE) and WTI Crude Oil.
Within the last five years, both saw their prices drop dramatically. Since most investors aren’t investing in WTI Crude Oil, let’s focus on GE. From January 1, 2012 through December 31, 2016, GE was up over 76 percent. Fast forward seven months and GE started its downfall.
From July 20, 2016 to January 19, 2018, GE’s stock price was cut in half much like airlines, cruise lines, and casinos today. Had you purchased GE when it was 50 percent off its high (January 19, 2018), and held it through April 10, 2020, you’d be down over 54 percent.
The chart above shows that just because prices are down, it’s not necessarily a good time or the right investment to buy.
What’s the Goal in Buying Airlines, Cruise Lines, and Casinos?
For the moment, let’s forget about the amount of money these companies are burning, the debt they are taking on to keep their collective heads above water, and how long these scenarios will last, all while taking in little to no income.
The dream scenario is you purchase these companies, they eventually recover, and the results provide a meaningful impact toward your future goals. Before playing out the dream scenario in your mind, you should be aware of the capital it would require and the amount of risk you should be willing to incur.
Associating a dollar amount to a meaningful impact will vary by investor. For illustrative purpose, let’s make some assumptions:
- Age of investors – 45
- Investable Assets – $1,500,000
- Meaningful Impact – $375,000
- What makes it meaningful:
- $375,000 is 25% of the account value
- $375,000 is five years of annual contributions ($75,000/year)
- $375,000 is two and a half years of expected income in the future
- What makes it meaningful:
Like other investors, you want to capitalize on airlines being down over the last 45 days. The airline stock that interests you was $100. It’s down 60% in the last two months and now trading at $40. You don’t believe it will get back to $100 in the next two years, but think it can get back to $60, a 50% upside from today. For your investment to make a meaningful impact, here’s what it would take:
For most, that’s an unrealistic scenario. Let’s look at a few different numbers. You still believe a 50% return is likely over the next two years, but don’t want to invest half of your portfolio:
Would you be willing to invest this amount of money on a gut feeling for potential returns? What if, after making your initial purchase, the airline stock performance looked more like GE than your expectation?
Understanding the Risk
This is where knowing about beta is important. Beta is a measurement of market risk or volatility. That is, it indicates how much the price of a stock tends to fluctuate up and down compared to other stocks.
A beta of 1.0 indicates that a security’s price activity is strongly correlated with the market. A beta greater than 1.0 indicates that the security’s price is theoretically more volatile than the market. While a beta below 1.0 is less volatile. For example, if a stock has a beta of 1.2, it’s assumed to be 20% more volatile than the market.
For reference, the beta numbers of one of the big names in airlines, cruise lines, and casinos are 1.953, 2.638, and 2.883, respectively. So compared to the market, these companies are 95.3%, 163.8%, and 188.3% more volatile than the overall market.
What if you didn’t make the investment in the airline stock and just kept the money invested in your current allocation?
You should compare the beta of the airline to your current investments. It’s possible to have an all equity portfolio that carries a beta of less than 1.0. In this scenario, let’s assume your portfolio’s beta is .867. You are taking 13.3% less risk than the market and 108.6% less than the airline, 177.1% less risk than the cruise line, and 201.6% less risk than the casino.
There isn’t a right or wrong answer in these scenarios because we won’t know the outcomes until some point in the future. But putting perspective and context around your decision holds a lot of value. If you are truly interested in purchasing these types of companies, have a plan. Understand the outcome if you’re right, what it means for your future goal, the risk associated to your decision, and what happens if you’re wrong and your choice company follows the pattern of GE instead of your dream scenario.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of John Geffert and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities. General Electric (GE) is being used as a hypothetical example for illustration purpose only.