If you ever meet someone that says “I’ve never made a mistake”, I will happily point out to you a complete liar. Nobody goes through life without making at least a few mistakes.
The trick however, is to not make too many of them. Keep the numbers low (if you can). Do that and you’ll sail through life with relative ease.
The key to keeping the numbers low, is learning from those mistakes. This is true in investing, and all other walks of life. Face your mistakes. Don’t ignore them. Don’t hide mistakes from others, and certainly don’t tell yourself, “I won’t do that again” and then repeat the same blunder all over again.
Along this same line of thinking, I thought it might be entertaining and instructive today if we took a look back at one of my big investing blunders ever.
Let’s review my investment in Southwest Airlines!
So how bad was my Southwest investment performance? I purchased shares back in August of 2017, roughly 3.25 years ago at an average purchase price of $52.98 per share.
Today Southwest shares trade at $61.05. On the surface this doesn’t sound so terrible, but look at a comparison with the S&P500:
Why did I ever believe Southwest was going to be a good investment?
Why Did I Invest?
Back in 2017, the world was a very different place. Airlines were actually pretty profitable back then. That’s right kids — People used to travel by plane regularly for work, and leisure. They went on vacations, flew to conferences, and visited different countries to experience the culture, sights, and food.
I know — it’s hard to believe the world has changed that much, right?
Back in 2017, I did a write-up on my reasons for investing, (and you can still read that post) but the reasons boil down to a few key ideas:
– Historically Southwest had earned good returns on equity (>20%). They were a solid, efficient operator with low debt levels.
– Big upcoming investments in the new 737 MAX would lead to efficiency improvements and the ability to compound capital at good rates of return.
– Cheap shale oil would keep the cost of aviation fuel cheap for years to come. This would likely mean higher levels of profitability for Southwest in the years ahead.
– The airline market in the U.S. has been reduced down to a few major players. Essentially, an oligopoly for all intents and purposes. Oligopolies are a form of market structure in which the limited number of players enjoy higher levels of profitability due to decreased market competition.
– Compared to the S&P 500, Southwest was a decent value. It was arguably the most efficient player in the U.S. airline business, earning returns on capital that exceeded that of the average S&P 500 business.
The future for Southwest Airlines looked pretty rosy back in 2017. I made the mistake of investing with the belief that the future would look pretty much like it had in the past…
Then, everything went to hell in a handbasket.
What Went Wrong
A few major things went wrong with this investment. The first signs of trouble began back in October 2018, when Lion Air flight 601 crashed in Jakarta.
If you recall, the 737 MAX was a brand new aircraft back in 2017, and only a few airlines had started to fly them. Southwest had placed a giant order for 737 MAX aircraft, and (at the time) was the largest operator of the 737 MAX in the United States.
After another tragic crash in Ethiopia, it became clear that something was very wrong with Boeing’s latest aircraft. The crashes and subsequent grounding of the planes ruined my compounding hypothesis for Southwest. The massive investment in a more efficient fleet of aircraft was NOT going to happen, and operating margins declined as a result of having to fly older less-efficient aircraft.
Sure, Southwest could still repurchase shares on the open market, but returns from this kind of compounding are pretty limited.
Then, Covid-19 began to rear it’s ugly head in early 2020. Essentially all air travel ground to a halt. Airports became ghost towns as travelers stayed away (for fear of catching the virus). Borders were closed, and international flights were canceled.
For a few weeks in April 2020, less than 100,000 people were flying per day (in the United States). Compare this to the roughly 2 million people flying per day back in 2019, and you can get a picture of how desperate things were for the airlines.
Thankfully the U.S. government recognized the continuing need for air travel after the pandemic, and provided necessary loans to keep the airlines afloat.
While these loans kept airlines (like Southwest) operating, the massively increased debt levels are bad for shareholders. Instead of cash flow being reinvested into the business or being distributed to shareholders, cash will be used to service these new debts.
Clearly, very little went right with this investment. In fact, most of the things that went wrong, I never even dreamed were a possibility when I first invested. I obviously misunderstood the risks, and this was a huge mistake on my part.
Against all odds however, things have begun to look up for Southwest. Vaccinations are happening, and people are beginning to travel again. Ever so slowly, air travel numbers are increasing. In the last 6 months alone, shares in Southwest have risen by 53%.
Pent up demand for leisure air travel will probably boost Southwest later this year, as more of the population gets vaccinated. LOTS of people want to travel again, and that increase in demand will probably boost ticket prices (in the short term).
Longer term however, Southwest faces a larger debt burden, and a aging fleet of aircraft. According to some sources, they’re about to place an order for 737-MAX aircraft again (now that the 737 MAX has been re-certified).
It’s not back to business as usual however — With greater debt levels, the ability of Southwest to reinvest in newer more efficient aircraft is going to be limited. On top of that, it may take several years before leisure and business travel demand get back to the levels we saw in 2019.
My big dilemma now is, “What should I do with this investment?” Should I sell, taking my meager gains and invest in something better? Or, should I hang onto my Southwest shares, hoping to eventually capture more gains as the business improves?
It’s a difficult decision, and I haven’t completely decided what I’ll do yet.
Should I Sell, Hold, or Buy more? I’d love to read your thoughts about this investment in the comments below!
[Image Credit: CNBC, Democratic Underground]