One of my favorite financial tools on the Internet is the site RobotDough.com. They recently released a unique new feature that could prove to be extremely useful. By entering your stocks into their portfolio section, the site will provide you with a list of red flags and what effect on the stock price each of those red flags is typically associated with. While a decline in the stock price may be caused by something else, there is a strong correlation between the red flags and the associated returns in the six months following their appearance, taking into account how the broader market performs during that time.
Let's take a look at how this works with an industry notorious for financial problems: the airline industry. While most of the major airlines suffer from some of the same red flags, like poor current ratios and growing accounts receivable, each has a few unique ones as well.
Average Return Minus Market Return
AMR Corporation (NYS: AMR)
Net income is negative
Delta Air Lines (NYS: DAL)
High P/E ratio
JetBlue Airways (NAS: JBLU)
Selling, general, and administrative expense growth is greater than sales growth
US Airways (NYS: LCC)
Positive income but negative free cash flow
Southwest Airlines (NYS: LUV)
Profit growth is decelerating
United Continental (NYS: UAL)
Sales growth is decelerating
These are all fairly straightforward, but it's useful to see how much of an effect each financial problem has. For example, while airline companies have often been pegged as losing money in aggregate over the years, AMR (the parent of American Airlines) is the only company in this group that actually suffered losses over the last year. Statistically, this is one of the worst red flags for the industry, which should come as no surprise.
But what's interesting is that a high P/E ratio is actually a worse red flag in this industry, suggesting that high-flying airline stocks eventually have to fall back down to earth. The average P/E of the group is about 16, while Delta is about 27, a high premium for a company that only came out of bankruptcy a couple of years ago.
Being able to see what effect a red flag typically has on the stocks in your portfolio will be very useful in evaluating how seriously you should take them when they appear.
At the time thisarticle was published Fool contributor Jacob Roche holds no position in any of the other stocks mentioned. Check out his Motley Fool CAPS profile or follow his articles using Twitter or RSS. Motley Fool newsletter services have recommended buying shares of Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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