Valuation always matters. And in this pandemic-plagued market, valuing specific firms and the market has become that much harder. Many COVID-hit plays with weak balance sheets sport a risk/reward equation that’s more akin to a long-dated option that could allow one to double up or lose everything. Such all-or-nothing propositions on names like Air Canada (TSX:AC) are not everybody’s cup of tea.
Warren Buffett isn’t interested in betting billions of dollars on airline stocks whose risk/reward equation reeks of long-dated options dependent on the outcome of a contingent event, and you shouldn’t seek to overexpose yourself to such names either, even though it is realistically possible to double your money over a short time frame with such plays.
Air Canada could double your money, but the name isn’t without its fair share of risks
If you’re a young investor with a diversified portfolio and uninvested cash sitting around in a TFSA, it can make sense to place contrarian positions across such all-or-nothing COVID-hit names to help you improve your overall portfolio’s risk/reward equation. As long as you understand the option-like nature of some of the severely battered stocks out there, only then should you seek to buy into such names in the face of a potential second wave of COVID-19 cases.
Consider shares of battered Canadian airline Air Canada. The firm’s business has been hurting immensely amid this pandemic and will be in survival mode for the duration of this pandemic. If a second (or third) wave of COVID-19 were to hit, the federal government could put forth harsher travel restrictions that could further cripple Air Canada’s business.
Fortunately, Air Canada has a somewhat decent liquidity position after previous raises. The company had also not blown as much as its U.S. peers on share buybacks in the years prior to the crisis. As such, Air Canada, I believe, doesn’t look like it’ll be the first airline to fall as this pandemic drags on into 2021.
Moreover, management has done a good job of what they can control. Capacity cuts and reduced cash burn rates buy Air Canada more time to wait for the arrival of a safe and effective vaccine. Once a vaccine is administered to the masses (possibly in 2021), I suspect Air Canada stock could prove to be severely undervalued and could more than double past the $32 mark.
While you could still stand to lose your shirt with the name if we’re to go without a safe and effective vaccine past 2021, I think the odds of Air Canada surviving to see better days are remarkably high. Even if we’re without a vaccine until 2021’s end, advancements in convenient and accurate testing could be enough to relax travel restrictions and get Air Canada stock back into the skies.
If you’re a fearless, young millennial who seeks upside and has an extra $1,000, Air Canada may be the horse to bet on. But the name is probably far too risky for those unwilling to buy a long-dated option on the arrival of a vaccine in 2021.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Joey Frenette has no position in any of the stocks mentioned.