Airlines are never an easy investment to make. It's a capital-intensive business. Competition is stiff. Even worse, the vast majority of your customers only care about price. Service is important to the airline industry, but when people are shopping for airline tickets, the first thing they are after is the lowest fare. Couple this with volatile energy prices, and airlines are difficult investments to handicap.

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Clear Skies In 2010
None of the above mattered in 2010, as most airline stocks soared high during the year. Against a 10% rise in the S&P 500 heading into the final weeks of 2010, airline stocks have outperformed the markets. Delta Airlines (NYSE:DAL) shares are up nearly 20% year to date, while United Continental Airlines (NYSE:UAL) have soared by nearly 40% in 2010. But unless you just picked airline stocks for 2010, it's been a bumpy flight otherwise. Over the past five years, Delta shares are down by nearly 35%. It's been a worse flight for investors in AMR (NYSE:AMR), the parent of American Airlines, whose shares are down over 50% in the past five years. During that time, the S&P 500 declined by about 3%.

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The Airline Standout
It would appear obvious that discount airlines would be the most likely to benefit in an industry where your customers are extremely price sensitive. In 2010, discount airline Jetblue (Nasdaq:JBLU) shares were up a solid 27% but still below that of Continental. What's obvious about the airline industry is that nothing is obvious. The sole exception, at least in the U.S., may be Southwest Airlines (NYSE:LUV). In addition to ultra-low rates, Southwest has managed to remain very customer friendly. For instance, it may be the only airline in the U.S. that doesn't charge a fee for the first piece of luggage. And years ago, when oil prices were over $100 a barrel, Southwest benefited from having hedged a majority of its fuel costs.

Southwest shares are up a solid 16% year to date. While not as impressive as some of the other airlines, shares are also down 20% over the past five years, significantly better than its peers. LUV shares may be among only a few airlines to propel higher in 2011. Earlier in 2010, the company announced it was acquiring low-cost airline AirTran (NYSE:AAI). While history has many more bad examples of airline mergers than successful ones, this one looks to fall in the latter category. AirTran's main hub is Atlanta, one of the busiest airports in the country, and Southwest currently has no presence in the city. Overall, the two airlines have very little in terms of overlapping routes.


Airlines Are Tough
Despite the necessity of flying, most airlines have a difficult time sustaining profitability. While 2010 was a good year for airlines in terms of performance, the industry will always be engaged in a price war. Unless an airline can successfully compete on price, profits will be hard to come by. And without profits, there's no value creation. (To learn more about the airline sector, see our Airline Industry Tutorial.)

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