American Airlines has been on fire lately. In the past six months alone, the company’s stock price has rocketed 67%, reaching $17.75 per share. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.

Is there a buying opportunity in American Airlines, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.

Despite the momentum, we're swiping left on American Airlines for now. Here are three reasons why we avoid AAL and a stock we'd rather own.

Why Do We Think American Airlines Will Underperform?

One of the ‘Big Four’ airlines in the US, American Airlines (NASDAQ:AAL) is a major global air carrier that serves both business and leisure travelers through its domestic and international flights.

1. Weak Growth in Revenue Passenger Miles Points to Soft Demand

Revenue growth can be broken down into changes in price and volume (for companies like American Airlines, our preferred volume metric is revenue passenger miles). While both are important, the latter is the most critical to analyze because prices have a ceiling.

American Airlines’s revenue passenger miles came in at 65.5 billion in the latest quarter, and over the last two years, averaged 8.9% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability.

2. EPS Trending Down

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for American Airlines, its EPS declined by 22.8% annually over the last five years while its revenue grew by 3.4%. This tells us the company became less profitable on a per-share basis as it expanded.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

American Airlines burned through $552 million of cash over the last year, and its $39.17 billion of debt exceeds the $8.47 billion of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the American Airlines’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of American Airlines until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

American Airlines falls short of our quality standards. After the recent surge, the stock trades at 8.9× forward price-to-earnings (or $17.75 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are more exciting stocks to buy at the moment. We’d suggest looking at Google, whose cloud computing and YouTube divisions are firing on all cylinders.

Stocks We Would Buy Instead of American Airlines

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