The airline industry is often viewed as being more risky than other types of companies in the service sector. The cyclical nature and high operating costs of the industry, in addition to the dependence on a strong economy, has caused the industry to be one of turbulence and volatility. Furthermore, following an economic downturn, typically there is a six-month lag before the airlines begin to recover.

IN PICTURES: 8 Financial Tips For Young Adults

Demand Elasticity

The demand for airline travel is significantly more elastic than the corresponding figures for other services. According to a study performed by Houthakker and Taylor, a 1%drop in income results in a 5.82% decline in airline travel spending, the highest on the list. The respective declines for movies and restaurant meal spending associated with a 1% income reduction are 3.41% and 1.61%, respectively.

If Unemployment Decreases

Although unemployment remains at a shocking 9.6%, average income and expenditures have slowly been increasing in recent months. A reversal of employment figures to pre-recession levels of approximately 5% would benefit the airline industry to a greater extent than other sectors. Due to the high demand elasticity of airline travel, a 1% rise in income would increase demand by 5.82%, while food and clothing purchases would increase by 0.14% and 0.51%, respectively.

Strong Performance

Strong earnings reports within the industry have shed some light on the airlines, which undoubtedly struggled during the recession. Southwest Airlines (NYSE: LUV) recently reported a $112 million profit, an increase from $91 million in the year-earlier period, as passenger revenue outpaced unit costs. Delta (NYSE: DAL), UAL Corp. (Nasdaq: UAUA), Continental Airlines (NYSE: CAL) and US Airways (NYSE: LCC) also showed fairly strong performances last quarter.

As a potential indicator of future performance, Boeing (NYSE: BA), which delivered 114 planes in the preceding quarter, is expecting to increase its 737 production rate to 35 units per month in 2012.

Southwest Airlines is valued highly, trading at 44 times earnings. The high valuation is due to the higher-than-industry-average company growth rate and solid liquidity ratios. Other regional airlines, such as JetBlue Airways (Nasdaq: JBLU), trade at lower P/E ratios but have higher leverage ratios. Southwest also operates with a higher efficiency level as its return on assets, investment and equity are higher than those of its competitors.

More Risks

Delta remains the largest major airline until the merger between UAL and Continental Airlines is complete. The major airlines operate at fairly slim margins, which has been much of the cause of industry criticism. Delta and US Airways, for example, have an operating margin of 3.38% and 3.42% respectively, while firms in other industries such as McDonald's (NYSE: MCD) operate with a corresponding metric of 30.87%. Obviously these are entirely different industries, but the gap in margins reflects the high risk of investing in the airlines. (Break through the clouds to see if these stocks will rocket higher or crash and burn. To learn more about the airline industry, see Is That Airline Ready For Lift-Off?)

Bottom Line

Risk-averse investors who don't mind portfolio volatility and expect the airline industry to prosper in upcoming years could find the industry attractive as traveling passengers resume their habits. According to IATA, passenger demand is currently up 11.9% on a year-over-year basis.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center