What to Do When the Market Asks You to Choose
Imagine that your phone rings…
It is your lawyer. They have some really sad but also really great news.
Apparently, you had a long-lost uncle who you were never told about. Sadly, this uncle has recently passed away.
Now for the good news. Your long-lost uncle had a long and wonderful life. He also didn’t have any children, and you are named as a major beneficiary in his will.
Better still, your lawyer tells you that this long-lost uncle was unfathomably rich. Not “a couple of million dollars” rich, but rather one of the richest people on the planet.
It turns out that your long-lost uncle was worth billions of dollars.
There is a bit of a complication, though, because there is a unique stipulation in your uncle’s will. You are going to have to make a decision…
The will states that you are required to select which of two specific pieces of your uncle’s estate you want to receive.
Your two inheritance options are…
- 100% ownership of web-based video conferencing company Zoom Video Communications (Nasdaq: ZM)
- 100% ownership of the seven largest airlines in the world based on revenue: Southwest Airlines (NYSE: LUV), Delta Air Lines (NYSE: DAL), United Airlines (Nasdaq: UAL), International Airlines (OTC: ICAGY), Lufthansa (OTC: DLAKY), American Airlines (Nasdaq: AAL) and Air France-KLM (OTC: AFLYY).
(I told you that this uncle was unfathomably rich!)
Now, before you decide, I’m going to give you a little more detail on your two options. It wouldn’t be fair to make you choose without at least looking at some numbers.
With big dollars like this on the line, you don’t want to rush to a decision.
The Last Full Year of Financial Statements Looks Like This…
The first thing that I thought of when I heard about your windfall options was how lovely it would be to own the seven largest airlines.
Can you imagine?
Free trips anywhere in the world, anytime you want them.
First class too! Why would you sit in coach if you didn’t have to?
Realistically, though, if you are going to be inheriting these seven airlines, you probably won’t have any trouble paying for your own first-class tickets.
If we drill into the financials, we can see that in their last full fiscal years (pre-COVID-19), each of the seven airlines posted respective pretax net incomes of the following…
- Delta Air Lines: $5.2 billion
- International Airlines: $3.5 billion
- Southwest Airlines: $2.8 billion
- Lufthansa: $2.5 billion
- United Airlines: $2.1 billion
- American Airlines: $1.8 billion
- Air France-KLM: $463 million.
Combine them all together, and the seven airlines that you might choose to inherit generated net income of more than $18 billion in their last full year prior to COVID-19.
Your other inheritance option is to take full ownership of Zoom.
Fortunately for us, Zoom recently filed its annual financial statements for the 12-month fiscal year ending January 31, 2020. That means we have some very fresh numbers to work from.
For those 12 months, Zoom’s pretax net income totaled $26 million.
Nice – but against the $18 billion-plus in net income of the seven airlines, Zoom’s financial performance looks pretty modest.
Zoom generated less than 1% of the net income that the seven airlines did.
Even with the troubles the airlines are facing, your inheritance decision looks pretty obvious…
Or does it?
The Market Believes Otherwise…
Despite generating just a tiny fraction of the net income that the seven airlines did, Zoom posted a market capitalization in May that was essentially equal to the combined market capitalization of the airlines.
Actually, Zoom’s market valuation in May was even a little higher…
To be clear, market capitalization is determined by share price multiplied by the number of shares outstanding. This is the total value that the market says a company is worth on any given trading day.
On May 15, Zoom’s market capitalization hit $48 billion.
On the same day, the market capitalizations of the seven airlines were as follows…
- Delta Air Lines: $12.3 billion
- International Airlines: $4.1 billion
- Southwest Airlines: $14 billion
- Lufthansa: $3.9 billion
- United Airlines: $5.9 billion
- American Airlines: $3.9 billion
- Air France-KLM: $2.1 million.
The total market cap of these seven airlines is $46.2 billion.
I find this incredible.
The market is saying that Zoom and its $26 million of income is just as valuable as the seven largest airlines and the combined $18 billion of income they generated in the year prior to the pandemic.
Clearly, the market is taking a very bullish view on Zoom’s ability to grow by a massive amount going forward.
Equally obvious is the fact that the market doesn’t think that the airlines are going to get back to their previous level of earnings anytime soon.
But what should you do? Which inheritance option should you go for? You are going to live with this decision for the rest of your life…
The market says both options are worth virtually the same…
But I don’t agree. I think the market has been putting far too much weight on what is happening and not enough weight on what will happen. We won’t be living in a COVID-19 world forever.
My opinion is that Zoom is being valued far too optimistically and the airlines too pessimistically. Zoom’s web video meeting conferencing business is great, but people are going to head back to the office eventually. And airline travel will recover.
For your “what if” inheritance decision, I’d definitely go for the airlines, although I still wouldn’t spend my own money buying shares of them. There are better options out there for your real money.
And I most certainly wouldn’t be buying shares of Zoom at its current lofty valuation.
The market often tricks investors into unequal choices like these. In our “what if” scenario, you had to pick…
Fortunately, in the real world, it is perfectly fine to say “No, thank you” to both.