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Why Investors Are Overlooking This Screaming Bargain

I took my son to preschool the other day and, for the first time, he ran off without saying goodbye to me -- he just saw his friend and off he went. I walked back to my car wishing I could turn the clock back to a time when my son didn't want to play with anyone but me.

As you probably guessed, this does have something to do with investing. In behavioral finance terms, I was anchoring my expectations to a time that seemed better.

In reality, kids grow up and become less dependent on their parents. Change is inevitable, and I need to accept that.

That last sentence also applies to stocks. The companies we invest in will change over time, and we will either accept those changes (the healthy thing to do with both kids and stocks) or fight them.

Anchoring can be a costly mistake.

Investors often look backward instead of forward. They may see a stock they like drop from $50 to $25 and argue it's extremely undervalued at $25 since it was a "good" stock at $50. They have anchored expectations to what they believed when the stock was trading at $50.

If the stock is being weighed down by the market or its sector, then it might actually be a bargain at $25. But if the decline is because the fundamentals have changed, investors need to recognize the changes rather than anchor an opinion to facts that are no longer relevant.

I am especially aware of the dangers associated with anchoring because I often see the same stocks show up on my screens for months at a time. Each time I see the stock, I need to be sure I base my evaluation on the current facts as opposed to bullish or bearish news from months ago.

In some cases, a stock that was a good trade a few months ago may no longer be a "buy." On the other hand, some stocks with bullish fundamentals remain undervalued for months.

Undervaluation can also be due to anchoring, thanks to bearish factors that existed in the past but have since been corrected. This is one of my favorite things to exploit as a trader.

Airline stocks are a prime example of this. They were bad investments for many years. Warren Buffett famously said, "If there had been a capitalist down there [when the Wright Brothers made their first flight in North Carolina], the guy would have shot down Wilbur. One small step for mankind, and one huge step for capitalism."

When Buffett said this, airlines were making a number of mistakes in their pursuit of profits, while multi-billion-dollar airlines were regularly resorting to bankruptcy to restructure themselves. But today's airline industry is quite different and is actually turning a profit.

The industry now seems to understand its business is flying people from city to city. When a passenger buys a ticket, all they get is a seat on the plane. If they want to bring luggage on their trip, that costs extra. On many airlines, if they want a particular seat, such as one next to their own child, that's extra too. Airlines have mastered capitalism and are now wringing profits out of passengers like never before.

One airline stock that has been repeatedly popping up on my screens lately is Delta Air Lines (NYSE: DAL ).

I first recommended Delta back in October, and those who took my advice made a nice profit. But I want to focus on what's new with the company to make sure I'm not anchoring on old facts.

On Jan. 19, Delta reported fourth-quarter earnings that were a penny less than analysts expected, yet the stock closed higher.

There was a lot of good news in the report despite the missed expectations, but the biggest story was probably fuel costs. Delta saved nearly $2.8 billion on fuel costs compared to the same quarter a year ago. With fuel prices still falling, Delta expects to pay about $1.20 to $1.25 per gallon for fuel in the first quarter -- significantly less than the $1.85 per gallon it paid in the fourth quarter -- which should boost profits.

In fact, earnings growth is expected to average 23% a year for the next five years. Analysts have also increased their earnings estimates for this year and now expect $6.91 per share, up from $5.71 three months ago.

Using the PEG ratio, which assumes a stock is fairly priced when its price-to-earnings (P/E) ratio is equal to its earnings per share ( EPS ) growth rate, we can determine a fair value of about $159 based on expected earnings. That is more than three times the current price.

I believe DAL's extremely undervalued price is due to anchoring. Many investors are anchored on the idea that airlines are a bad investment. As they realize the industry has changed, I expect airline stocks to trade at significantly higher P/E ratios and believe DAL could at least double from its current price.

DAL is a long-term buy, but for those traders who want profits now, there is an alternative strategy.

It involves options and it's not for everyone. It's different, and there's no guarantee you'll make money using it.

But I'm proud to say that, on average, it's delivered annualized returns of 53% per trade since I started showing it to investors. Not only that, it's delivered gains 100% of the time so far.

And the best part is, if you have just eight minutes, I can teach it to you. I promise it will be time well spent. Watch my free training video here.

This article was originally published on ProfitableTrading.com: Why Investors Are Overlooking This Screaming Bargain​

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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