Two important investing lessons regarding the possible bankruptcy of Spirit Airlines; The opportunity in small- and mid-cap stocks

1) I'll admit that I breathed a sigh of relief when I saw the big news about Spirit Airlines (SAVE)...

The discount airliner is reportedly in talks about a possible bankruptcy filing (the Wall Street Journal broke the story last night in this article: Spirit Airlines Explores Bankruptcy Filing). And the news triggered a crash in Spirit's stock of as much as 38% this morning.

You see, I had bought the stock in my personal account a little more than year ago because I thought there was a greater than 50% chance that a judge would allow JetBlue Airways (JBLU) to acquire Spirit at $33.50 per share, so the expected value was significantly higher than the $15.89 I paid. (For more on what the investment thesis was at that time, see this write-up posted on Value Investors Club on August 16, 2023.)

To this day, I think it was a good bet...

Both JetBlue and Spirit needed the merger to gain the size needed to compete against the "Big Four" carriers that dominate the U.S. airline market: Delta Air Lines (DAL), United Airlines (UAL), American Airlines (AAL), and Southwest Airlines (LUV), which have a combined 80% market share.

The government argued that if JetBlue and Spirit merged, it would reduce competition and lead to higher prices. But this ignored the possibility that if both companies went bankrupt, that would really reduce competition and the Big Four would surely jack prices through the roof.

But on January 16, the judge ruled in favor of the government and Spirit's stock crashed that day by 47% (I, of course, knew this was a possibility so had sized this appropriately at 1.6% of my portfolio). As a result, I exited my position a bit later.

So the first lesson here is that sometimes, even if you make a good bet, you get unlucky and lose money. You mustn't let this deter you from making similar investments in the future.

And similarly, sometimes you make a bad bet that nevertheless pays off. While this, of course, feels great... it can be very dangerous because it rewards – and can therefore encourage more – reckless behavior.

Regardless of how a bet like this ends up, it also underscores the importance of appropriate position sizing. Never put more money at risk than you can afford to lose. Again, in the case of Spirit, I kept my position small at 1.6% of my portfolio.

The second lesson relates to the decision I had to make: having lost half my money, should I buy more, sit tight, or sell?

The natural human inclination when you suffer a big loss is to feel sorry for yourself, lick your wounds, and hunker down – waiting/hoping/praying for the stock to recover to your purchase price so you can exit with your investment (and dignity) intact.

This is exactly the wrong thing to do.

The market doesn't know what your purchase price was, doesn't care about your dignity, and isn't listening to your prayers.

Instead, you need to put your emotions aside and ask yourself a simple question:

If I didn't already own the stock, would I buy it today at this price?

Importantly, you must avoid inventing new reasons to own the stock.

In my case, my investment thesis was based on a single pillar: that a judge would rule in favor of Spirit and I would quickly double my money.

Once that pillar was blown out, it would have been easy to try to replace it with another one, rooted in how cheap Spirit's stock appeared. Emotionally, that's what I wanted to do because then I wouldn't have to recognize the loss – as long as I held on, the stock could always recover.

But I was able to put those feelings aside and realize that I didn't want to make a completely different bet on the turnaround of a money-losing, undersized company in a terrible industry... so I exited my position not long after the ruling.

As Warren Buffett once said, "You don't have to make it back the way you lost it."

2) I've been saying for a while that small- and mid-cap stocks are likely to outperform large-cap ones (see my June 18 and July 8 e-mails)...

One of my analysts agrees, and he recently put together a handful of slides for a presentation last month making this case – which I'll share today...

He started by showing the forward price-to-earnings ("P/E") multiples for the S&P 500 Index of large-cap stocks, recently at about 18 times, and the S&P 600 Index of small-cap stocks, recently at only 12.2 times:

He then shared this slide showing that the ratios between the forward P/E multiples of the two indexes (also including the S&P 400 Index of mid-cap stocks) recently hit the lowest level since 2001:

The last time this happened, small-cap stocks (as measured by the Russell 2000 Index) outperformed by a wide margin, as shown in this chart from the June 23 Week in Charts blog post from Creative Planning's Charlie Bilello:

"But..." you might be thinking, "There's a good reason that large-cap stocks are so much more expensive: it's because their earnings growth has been much better, right?"

Wrong!

As my analyst showed in this next slide, the earnings of small- and mid-cap stocks grew faster from the March 2009 market bottom until the start of the pandemic, and even more so in the recovery since then:

But not all small-cap stocks are created equal...

I would be wary of the nearly 40% of small-cap growth stocks that are losing money – take a look at this chart from investment-management firm Wellington Management:

In conclusion, I'm not saying that you should rush out and sell any large-cap stocks you own...

Yes, they're richly valued by nearly all historical measures, but I don't think they're in bubble territory by any stretch of the imagination.

But I definitely still have my eye on small- and mid-cap value stocks.

And here at Stansberry Research, my colleague Bryan Beach agrees that small caps are particularly appealing right now...

He recently put together a special presentation with all the details of the specific opportunity he sees – as he says, it's as rare and lucrative of a setup as you'll ever find in the markets.

In short, Bryan says a window of opportunity that recently opened will likely be the best chance you'll ever have to get in on the "ground floor" with several tiny stocks – ones that he expects to thrive in the coming years. Get all the details here.

Best regards,

Whitney

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