Understand Southwest Airlines Company (LUV) as Benjamin Graham Would

Southwest Airlines Company does not have the profile of a defensive investment based on the requirements of Ben Graham. The Airlines firm may nonetheless be of interest to more risk-oriented investors who have a solid thesis on the company's future growth. At Market Inference, we remain agnostic as to such further developments, and prefer to use a company's past track record as the bellwether for future potential gains.

Southwest Airlines Company Is Probably Overvalued

Graham devised the below equation to give investors a quick way of determining whether a stock is trading at a fair multiple of its earnings and its assets:

√(22.5 * 6 year average earnings per share (1.86) * 6 year average book value per share (18.113) = $18.78

At today's price of $29.88 per share, Southwest Airlines Company is now trading 59.1% above the maximum price that Graham would have wanted to pay for the stock.

Even though the stock does not trade at an attractive multiple, it might still meet some of the other criteria for quality stocks that Graham listed in Chapter 14 of The Intelligent Investor.

Positive Retained Earnings From 2008 To 2022, An Acceptable Record Of Dividends, and Decreasing Earnings Per Share

Ben Graham wrote that an investment in a company with a record of positive retained earnings could contribute significantly to the margin of safety. Southwest Airlines Company had positive retained earnings from 2008 to 2022 with an average of $10.43 Billion over this period.

Another one of Graham's requirements is for a 30% or more cumulative growth rate of the company's earnings per share over the last ten years.We are going to compare Southwest Airlines Company's earnings per share averages from the two 'bookends' of the 16 year period for which we have data. The first bookend comprises the years 2007, 2008, and 2009, whose EPS values of $0.84, $0.24, and $0.13 average out to $0.40. Next we look at the years 2020, 2021, and 2022, whose values of $-1.54, $1.61, and $0.87 average out to $0.31. The growth rate between the two averages does not meet Graham's standard since it is -22.5%.

Shareholders of Southwest Airlines Company have received regular dividends since 2008. The company has returned a 1.8% dividend yield over the last 12 months.

Negative Current Asset to Liabilities Balance and an Average Current Ratio

Graham sought companies with extremely low debt levels compared to their assets. For one, he expected their current ratio to be over 2 and their long term debt to net current asset ratio to be near, or ideally under, under 1. Southwest Airlines Company fails on both counts with a current ratio of 1.4 and a debt to net current asset ratio of -0.8.

Conclusion

According to Graham's analysis, Southwest Airlines Company is likely a company of average quality, which does not offer a significant enough margin of safety for a risk averse investor.