Five lessons from when I tripled my money on JetBlue Airways

I'll never forget one airline CEO's wise words of warning...

Back in 2003, I interviewed Jonathan Ornstein – the CEO of Mesa Air (MESA) – and I still remember what he told me: "You can't own airline stocks. You can only rent them."

I've generally followed his advice and avoided this terrible sector, for reasons that Warren Buffett outlined in his 2007 annual letter to Berkshire Hathaway (BRK-B) shareholders:

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.

Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.

That said, I have my eye on a stock in the sector right now: Southwest Airlines (LUV). And a potential setup in it reminds me of one of my most successful investments, when I tripled my money a decade ago owning JetBlue Airways (JBLU).

So in this e-mail, I'll set the stage for taking a closer look at Southwest by reviewing what happened back then with JetBlue so we can evaluate if Southwest today might be a similarly profitable investment...

My history with JetBlue dates back two decades when, intrigued by this new company that promised to shake up a hidebound industry, I wrote five articles about it in 2003 for The Motley Fool (here's a PDF of them):

• "The Amazing JetBlue" (June 20, 2003)
• "JetBlue's Beautiful Cost Structure" (July 11, 2003)
• "JetBlue's Customer Experience" (July 25, 2003)
• "JetBlue's Friendly Skies" (August 8, 2003)
• "JetBlue's Challenges" (September 19, 2003)

While I liked the company, I didn't buy the stock for reasons I outlined in my final column, "JetBlue's Challenges":

In the four columns I've written about JetBlue Airways over the past three months, I've expressed tremendous admiration for the airline – in particular, its cost structure, customer service, and culture – and concluded in my initial column that JetBlue "has a decent chance to become the Wal-Mart (WMT) of the airline industry over time."

That being said, this upstart airline operates in what remains one of the worst industries imaginable and faces significant challenges, factors that I'm not sure investors are considering fully given the nose-bleed valuation they are assigning to the stock (at yesterday's close of $59.13 [$29.57 split-adjusted], it trades at 44.5x this year's consensus analysts' estimates of $1.33 and 32.2x next year's estimates of $1.73).

While I did not recommend the stock three months ago at $39.71 [$19.86], I did pay it a great compliment by saying, "If I were forced to buy one stock trading in excess of 35 times this year's estimates, it would be JetBlue." I can no longer say this today, given the substantial run-up in the stock since then and my greater appreciation for the many challenges JetBlue faces. Let's talk about a few of them, keeping in mind that after extolling the company's many virtues for four columns, I'm going to give skeptics a full hearing.

... As an admirer of JetBlue – and a New York City resident who benefits from its presence in the market – I hope the company is successful, but I'm not even tempted by the stock at these levels.

It was a great call, as the stock collapsed and then languished for the next decade. But then it soared, giving me the opportunity to triple my money in the hedge funds I was managing at the time. You can see the moves in the chart below:

So how did I catch this move?

On May 4, 2014, a friend attending the Ira Sohn investment conference sent me pictures of a slide presentation given by Will Snellings of the Marianas Fund.

I had (and still have) no idea who he was... but he made a compelling presentation that, under new management, JetBlue's earnings were about to soar due to a number of factors:

• The lowest cost structure, due in large part to the youngest fleet in the industry
• The rollout of first class (Mint) seating on transcontinental flights, which would boost depressed margins to industry peers
• Redeploying planes to higher-margin routes
• Charging $25 for the first checked bag
• Adding two rows of economy seats on most planes

Here are the pictures of two of Snellings' slides that my friend sent me:

I immediately took a look at JetBlue's financials and saw that over the previous five years, the company's revenues had grown strongly but operating income was stagnant. Here's the chart I put together at the time:

Given my background knowledge and industry contacts dating back more than a decade, it didn't take me long to conclude that Snellings was correct that JetBlue's earnings were about to soar. Sure enough, as you can see in this chart that I put together a couple years later, operating income (in millions in the chart) soared:

Not surprisingly, the stock followed suit – from early May 2014 when I bought shares, it tripled by mid-2015.

At that point, I sold the stock because I saw that JetBlue had pulled all of the levers to increase profits that Snelling had outlined, so there was no more upside. The company had reset its profits – and stock – but was now just another company in a terrible sector.

It was another great call, as the stock has collapsed (again) over the past decade. Take a look at the long slide lower:

There are five big lessons here...

• New management often has the opportunity to pick low-hanging fruit to drive increased profitability – for example, I discussed this possibility for Starbucks' (SBUX) new CEO in my August 14 e-mail,
• Just because an upstart company is shaking up a stodgy industry doesn't necessarily mean it's a great stock,
• Stocks follow earnings,
• The key to successful investing is identifying an earnings inflection point that's not anticipated by the market, and
• Spending the time to learn about a company/industry and build relationships can really pay off – though sometimes, a lot of patience is required.

So in this context, tomorrow and Thursday I'll look at Southwest to see if it might be a compelling investment like JetBlue was for me back in 2014... so stay tuned!

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.