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Trade These Under $7 Stocks for Up to 63% Gains by Summer

Michael J. Carr and Amber Hestla-Barnhart

Value investors often find several attractive stocks in a particular industry. For example, after the 2008 financial crisis, value investors picked through what remained of Wall Street firms and big banks. Bank of America (BAC) has gained more than 400% since the panic selling in this sector ended and Wells Fargo (WFC) has gained nearly 390%. Big gains like that over four years remind investors that buying the bottom is not required to enjoy the rewards of value investing.

One sector that many value investors have ignored so far is airlines. This might be related to Warren Buffett's famous assessment of the industry:

"The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down."

Since Buffett wrote that in 2008, airlines have delivered three straight years of profitability and analysts expect 2013 to extend the streak.

Airlines may finally have found a winning formula with fees for checked bags and other services now adding to their bottom lines. Travelers may not like the fees, but the industry does and it looks like fees may be the factor finally allowing airlines to maintain consistent profits.

This sector has been a stock market leader this year and prices are breaking out of a triangle that dates back to 2008. The monthly chart shows that now could finally be the time to buy.

Airline Sector Chart

There is no longer an ETF available to trade the airline sector, but there are a couple of very inexpensive stocks that are strong buys right now. JetBlue Airways (JBLU) and Hawaiian Holdings (HA) both trade for less than $7 a share and less than 10 times next year's expected earnings.

JetBlue operates 180 aircrafts flying routes in the United States, the Caribbean and Latin America. The company has seen sales increase by an average of 11.9% a year in the past five years while earnings per share (EPS) increased 35.9% a year. Analysts expect earnings growth to average 30.9% in the next five years.

JBLU is one of the most undervalued stocks in the market right now. The PEG ratio, which compares the P/E ratio to the expected earnings per share (EPS) growth rate, is less than 0.4. Fair value for the PEG ratio is usually considered to be 1, so JBLU could more than double based on this measure of value.

Hawaiian Holdings operates 43 aircrafts on routes between cities in the United States and Asia. Revenue has grown at an average of 14.8% a year in the past five years while EPS grew 28.2%. Going forward, analysts expect EPS growth of 27%.

HA is another of the most undervalued stocks in the market right now. The PEG ratio is only 0.2 for HA, below fair value and less than one-sixth the industry average of 1.26.

JBLU has the stronger chart with relative strength (RS) at 100 and a completed triangle pattern with a price objective of $7.63, about 10% above the current price.

JetBlue Stock Chart

HA has more risk and higher potential rewards. Prices are still below the upper line of a rectangle, at $8.35, that has been forming for about 18 months. The potential gain is about 31% above the current price, but the risk is greater because RS is still low and the pattern has not yet been completed.

HA Stock Chart

Airlines are among the strongest sectors in the market right now and most, including these two, are expected to reported earnings at the end of April. Those announcements could be a catalyst to push stock prices even higher, and these low-priced stocks could be among the biggest winners if that happens.

Conservative traders should look at JBLU, using the 20-day moving average as a stop. This will allow them to minimize risk and maximize the potential gain if JBLU overshoots the price target on the upside. Aggressive traders might like HA better using a call option strategy to limit risk with a potential double-digit percentage gain.

Recommended Trade Setups:

-- Buy JBLU at $7.10 or less
-- Set initial stop-loss at $6.48, using the 20-day moving average as a trailing stop
-- Set initial price target at $7.63 for a potential 7% gain in 1-3 months

-- Buy HA July 6 Calls at $0.80 or less
-- Do not use a stop-loss (risk is limited to the amount paid for the option)
-- Set price target at $1.30 for a potential 63% gain in 4 months

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