Warren Buffett Portfolio [4 Investments that Make No Sense]

Why is Warren Buffett investing in airline stocks and could it be one of his worst investments ever?

Warren Buffett has gone from calling this industry a death trap for investors to buying four stocks worth almost $10 billion.

Buffett is known as a value investor and has been able to call a turnaround in stocks before. Following his investment into airline stocks may be one of the best you make or it could lose a lot of money.

We’re going to look into why the Oracle of Omaha now loves this industry and my two favorite stock picks.

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What's in the Warren Buffett Portfolio?

The Warren Buffett portfolio includes just 42 companies for a total of $196 billion and is surprisingly concentrated in a few industries.

Now if you follow Warren Buffett and his investing, that lack of diversification, those big bets in just a few companies shouldn’t surprise you. Buffett has often said that he thinks diversification is bunk and that it only holds your portfolio back from larger gains on your best investments.

What will surprise you though are some of the investments Buffett has made. In fact, he’s gambled more than $9 billion on just four companies and it’s got a lot of analysts scratching their heads.

Buffett took the lead for the Berkshire Hathaway holding company in 1965 and has rewarded investors ever since. Returns on shares have climbed 20% annually over the last 38 years, more than doubling the return on the broader market. That means instant market-buzz anytime the company files its Form 13-F, that’s the disclosure all large money managers have to file every three months.

That look into Buffett’s investments is what we’re using for this video series on the Oracle of Omaha’s stocks. We’re looking at Buffett’s biggest investments, his favorite industries and even his worst investment. We’ll look at the stocks Buffett believes in, why he loves them and how you can use all this to find your own investments.

From Death Trap to Buffett's Favorite Investments

Back to one of Buffett’s most surprising investments though, he’s put almost 5% of the portfolio in an industry that has always been trouble for investors. In fact, as recent as 2013, he was calling this industry a death trap for investors.

At the 2013 shareholder meeting, asked if Berkshire would ever consider adding another airline to its investments, Buffett warned that the industry was,

“a labor-intensive, capital-intensive, largely commodity-type business.” And went on to say, “It’s been a death trap for investors ever since Orville took off.”

Despite all this and almost losing his entire investment in the US Air investment of the late ‘80s, Buffett started buying airlines in late 2016. Berkshire now owns a major part of the Big four U.S. carriers; Delta, Southwest, United Continental and American.

So what does the Oracle of Omaha see that other investors don’t and is there still any room left in the returns to these stocks?

Why Does Buffett Invest in Airline Stocks?

Buffett has said that airlines have learned to operate with more discipline and are no longer adding capacity through huge fleet buying and new routes. He’s right here in that capacity growth has come down, mostly through consolidation in the industry. Obviously the plunge in prices for jet fuel, the single largest expense for the airlines, hasn’t hurt either.

And Buffett has done well over the two years through the beginning of 2018. The industry ETF the US Global JETS Fund, symbol JETS, has surged just over 40% versus a 30% gain on the broader S&P 500.

As for a long-term investment though, has the tailwind come out of the airlines? Since the beginning of 2018, the ETF fund has fallen 11% compared to a flat broader market. Energy prices are back up and some cracks are starting to show in the airlines’ financials.

So let’s look at the industry and why I think you can still make solid returns in two airline stocks in the Warren Buffett portfolio.

Even with a recent agreement among OPEC to increase production, geopolitical worries like the unravelling of the Iran nuclear deal as well as generally good global economic growth are likely to keep oil prices higher.

That’s bad news for an industry that books a large part of its operating costs for fuel. The IATA forecasts fuel as a percentage of industry operating costs will rise to 20.5% this year from 18.8% in 2017.

Against the current pessimism on higher fuel costs, there’s reason to believe the worst is baked into shares and there are a couple of airlines that stand out.

The Bureau of Transportation Statistics reported revenue passenger miles for U.S. carriers was up 4.8% in the first three months of the year, versus 2017. That’s a solid gain as seat miles has stayed fairly consistent.

Revenue freight ton miles for U.S. carriers have jumped 7.4% on a year-over-year basis. Tightened regulations in trucking and a driver shortage is benefiting air carriers and it’s a trend that should continue for at least a couple of years.

So even if higher fuel prices take some of the boom out of airline stocks, there’s still some good reason to be bullish, so let’s look at a couple of my favorite names. Two that Buffett happens to own as well.

Best Airline Stocks for Your Portfolio

I pulled data from the Bureau of Transportation and Bloomberg to look at the major U.S. carriers. In terms of passenger growth, Southwest and United have really pulled out ahead though passenger yield, that’s a measure for passenger profitability, is very low for United. I love American and Southwest’s commanding lead in market share as well as strength in that passenger yield.

American Airlines (Nasdaq: AAL) is my top pick among the major carriers. Profitability took a big hit last year when wages were increased significantly and management has already acknowledged higher fuel prices with a cut to its earnings target for this year. Taking the wage hit last year should mean less pressure in 2018 and margins could surprise to the upside.

American Airlines has one of the newest fleets in the industry with an average fleet age of just 10.1 years. That could free up cash flow to be returned to shareholders and help the company improve its balance sheet.

Shares trade for just 8.6-times trailing earnings, one of the lowest in the industry, and analysts expect profits higher by 9% to $5.48 per share over the next four quarters. Despite slower passenger growth over the year through January, the company still commands the largest share of the market and a turnaround in profitability could drive strong results.

Southwest Airlines (NYSE: LUV) has one of the best records for customer satisfaction and that could help it weather the recent incidents around equipment failure. The company is one of the few to escape bankruptcy over the last few decades, posting 45-consecutive years of profitability. Southwest holds the second-highest share of the domestic market and has experienced strong passenger growth over the year through January.

Southwest has also recently modernized its fleet to an average fleet age of just 11 years. The modernization has helped increase average seats per aircraft and lowered operating costs with an increase in average seat miles (ASM) per gallon of 5% over the past five years.

The company has one of the strongest balance sheets in the industry and is one of only three major carriers with an investment-grade debt rating. Shares trade for 14.6-times trailing earnings which are expected 26% higher to $4.60 per share over the next year.

Even with the selloff this year, Buffett has done well on his airline stocks but he’s not without his bad calls as well. In fact, he sold out of one investment last year losing almost $1.7 billion. In the last video in the Warren Buffett portfolio series, we’ll look at his worst investment and where it went wrong.

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