The last few weeks, I’ve been waving my yellow caution flag to tell you to be careful what you buy and when you buy it. Using the Standard and Poor’s 500 as an example, the index currently trades at 14.2 times forward earnings -- not outrageous, but higher than last year’s 12.6 times.
With 93 percent of companies reporting earnings for the second quarter, I found that earnings per share were up 2.1 percent while sales climbed 1.8 percent. Nonfinancial companies in the S&P 500 are showing operating margins at 13.6 percent -- still above the historical average of 12.1 percent.
Analysts now seem to be backing away from their forecasts earlier this year that had earnings estimates higher, and we may see them come down a little more in the next couple of months. But don’t panic -- this has happened in 29 of the last 37 years, and you know what the market did? It produced compounded yearly returns of more than 11 percent per year. So what is an investor to do? Diversify that portfolio.
While you may see EPS cuts in consumer dictionary and telecom stocks, technology and health care could prove to be winners.
Another industry that has caught my attention is the airlines. Yes, the airlines. Let me caution the investor that not all airlines are created equal. One that stands out is Southwest Airlines (NYSE: LUV). I also like the airline industry because there is currently some turbulence going on with American Airlines (Nasdaq: RJET), bankruptcy talk, regulations, all kinds of messy talk that can bring down all companies within that industry, but the strong businesses will prevail.
Southwest Airlines has a current market cap of $9.3 billion. At first glance, the valuation ratios look high on Southwest, showing a PE of 25.1 -- well above the industry at 19.2. Price to sales is also slightly higher for the company at 0.54, compared to the industry at 0.39. Price-to-book value favors Southwest at 1.62 since the norm for the industry is no price to tangible book at all. Price-to-cash flow reverts back to favoring the industry at 4.68 below the company at 7.4
Southwest also does pay a decent dividend of 1.2 percent, well above the average for the industry of 0.15, and the company uses only 13.5 percent of its earnings to pay that dividend.
Sales for the company and the industry look rather light: 1.1 percent year over year for the last 12 months for Southwest and 1.3 percent for the industry average. Earnings per share look good for the company, showing a 16.7 percent growth year over year for the last 12 months. The industry average shows a 1,300 percent gain, which I think comes mostly from a lack of earnings in the previous 12 months.
Airlines are known for having weak balance sheets and holding a lot of debt, so I’m happy to report that Southwest has a debt to equity of only 48.3. Compare that to the industry average of 570 percent and one can see why I’m not a big fan of all the airlines. The current ratio for the industry is 0.84. The same goes for Southwest. I wish it were a little higher, but if we invest in this company I can tell you I will be watching that closely. I was also a little disappointed with the return on equity of only 5.6 percent when the industry was at 37.1. I would be much happier if the ROE were about 15 percent.
Airlines don’t have the biggest profit margins, which are evident by the industry average of 2.05 percent; Southwest is slightly better at 2.20 percent. When it comes to efficiency, Southwest does a better job than the industry with its receivables turning over 33.9 times over the last 12 months -- far better than the industry average of 23.7. Inventory turnover did favor the industry at 30.4; Southwest was at 18.9
Looking out until December 2014, the mean of 16 analysts are looking for earnings per share of $1.19, a 23 cent jump over December 2013. Over the last 90 days, analysts have been reducing their EPS estimates, but only by 4 cents for December 2014. With the stock currently trading about $13 per share, investors are paying only 10.9 times forward earnings. Using my 40-year average, forward PE of 16.5 would yield investors a potential target sell price of $19.64.
So watch your buys closely, don’t be in too much of a rush to invest in a company, and maybe Southwest Airlines can lift your portfolio return.
Have a question or a company you'd like me to take a look at? Email me at firstname.lastname@example.org.
Wilsey is president of Wilsey Asset Management and can be heard at 8 a.m. every Saturday on KFMB AM760. Information is provided by Reuters.