3 reasons Southwest Air could double in value

The carrier sports a low valuation and a profit outlook that is sky high.

By Traders Reserve Oct 28, 2013 12:48PM

Southwest Airlines passenger planes are seen at Chicago's Midway Airport. Karen Bleier/AFP/Getty ImageBy Jamie Dlugosch


It's that time of year again, when I'm researching the stocks that will make my list of top stocks -- a list of stocks that regularly outperforms the market and by a large margin.

 

I like to call the stocks that make it on to this list "million-dollar stocks." That’s because owning these stocks can help you build your own million-dollar portfolio.

 

The blueprint for doing just that includes owning stocks that are primed for big gains. You can’t build a million-dollar portfolio owning index funds that track the market and their history of tepid returns.

 

Nope, if you want to build a million-dollar portfolio you need a set of rules and then the right stocks to own. As for owning the right stocks, how about Southwest Airlines (LUV)?

This stock has soared 18% since the beginning of the month, but that’s just the beginning.

 

Without getting too much into the details of what led me to Southwest (I use a proprietary stock ranking system -- something I like to call the P/E Gap), what I see here is a stock that has the potential to double in value in a very short period of time.

 

It is that doubling in value that can have you getting to a million dollars a lot quicker than standing idly by in an index fund. Here are three reasons why Southwest Airlines will continue flying high:


Valuation
The beauty of the P/E Gap is in its simplicity. Essentially the idea is to own stocks with strong profit-growth expectations and yet trading for a low valuation. In the case of Southwest, analysts expect the company to grow profits by 17% in 2014. At current prices, shares trade for 14 times 2014 estimated earnings. That P/E Gap was much larger before the stock appreciated nearly 20% in October. Nonetheless, there are still gains to be had.

 

It is likely that profit estimates for Southwest are too low. In fact, the CEO of the company just hinted that Southwest may begin charging fees for baggage. In an environment that is very strong for the airline industry, profits are flowing. Given the constraints of capacity, those profits numbers are baked in for some time.

 

What sort of earnings will it take for Southwest to double in value from here? Well, assuming a similar multiple of 15 times earnings, the company would have to grow to $2.30 per share. That’s a dollar per share more than current expectations for 2014. Look for that number at some point in 2015.

 

Competition

The airline industry used to be a horrible business to own. Intense competition on fares after deregulation gutted the industry. There have been numerous bankruptcies and at the same time new start-ups poised to take up the slack. The problem is that there was too much slack.

 

But that is no longer the case. What is interesting with Southwest is that the company is beginning to act more and more like the hub-and-spoke airlines that had originally opened the door for a discount point-to-point airline to be born and thrive.

 

This fee for baggage is just the start. Southwest continues to grow its routes. It is morphing into a monster -- a monster profit-maker. That’s a good thing for investors. Even better is the continued consolidation in the industry. There are simply not enough planes in the air to relieve prices. As long as that continues to be the case, Southwest can operate free and clear. Conditions are ripe for $2-per-share in earnings or significantly more.

 
Momentum
What has been working of late will likely continue to work in 2014. That means momentum and more momentum. Momentum stocks enjoyed a great run in 2013, but it was just the start. Bull markets of the age similar to where we are at today tend to end with blow-off rallies. And those rallies can be very spectacular.

 

Investors gravitate to what’s working on Wall Street. All that buying creates the momentum that can propel a stock to nosebleed heights. Shares of Southwest have gained nearly 70% so far in 2013. Look for a repeat performance or even more with a strong rally in 2014.

 

More from Traders Reserve


 

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