Today’s Best Turnaround Stock

Doubling your money in one year is impressive. But doing it two years in a row? That shows some impressive stock picking chops.

That’s why today I’m interviewing George Putnam III, Editor of The Turnaround Letter. Putnam is on track to make Dick Davis Digests history by choosing our best-performing Top Pick two years in a row.

Putnam’s selection for our 2012 Top Picks stock-picking contest was OfficeMax (OMX), and between his recommendation in January 2012 and when we tallied up the results at the end of the year, the stock more than doubled, handing our readers 110% gains.

This year, he seems about to do it again. His Top Pick for 2013, MGIC Investment Corp. (MTG), is already up 165% year-to-date. If it can preserve those gains, MTG stands a very good chance of making Putnam our top stock picker two years in a row.

Want to know his secrets? Then read on for his interview, his top stock-picking tips and his favorite turnaround candidate today.

Chloe Lutts Jensen: Hi George, thanks for talking to me today. Let’s begin at the beginning. When did you found New Generation Research and The Turnaround Letter and why did you decide to focus on bankruptcies and turnarounds?

George Putnam: I founded New Generation Research and launched The Turnaround Letter in 1986. When I was practicing law a few years before that, I did a lot of work helping to bring the former Reading Railroad (it was a real company, not just a space on the Monopoly board) out of bankruptcy. From that experience, I learned that most investors did not understand bankruptcies and turnarounds, and therefore there was opportunity to make money in that sector. Put another way, it was an inefficient niche in the otherwise fairly efficient stock market.

By the way, the guys who bought into the Reading during its bankruptcy made a killing—maybe that influenced me a bit too.

CLJ: How do you pick the investments recommended in the letter?

GP: We look for a number of things. Generally, there must be a solid core business that the company can use as the foundation for its turnaround. Among other things, we like to see well-known brands. We also like to see a change in management because the management team that gets a company into trouble usually won’t be able to get it back in its feet. If the balance sheet had too much debt or the cash flow was negative, the company needs to be doing something to fix those problems.

CLJ: Are there any red flags that suggest you should avoid an otherwise promising stock?

GP: If the company has too much debt on its balance sheet and doesn’t have a good plan for reducing debt, that will hurt its chances of turning around.

CLJ: Are some times better than others for finding good turnaround candidates?

GP: One strategy that we like is looking for year-end bounce candidates. Stocks that have performed poorly during the year often get oversold in December for two reasons: individual investors sell them to take tax losses to offset other gains they may have; and professional money managers dump their losing stocks so they don’t show up in the manager’s year-end portfolio reports. Both of these selling pressures go away on January 1, and so the over-sold stocks can rebound sharply. We typically devote part of our December issue to identifying some year-end bounce candidates. The strategy doesn’t always work, but it has done very well the last few years.

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CLJ: What’s one of your favorite investments to buy today?

GP: I really like BP plc (BP). The stock is very out of favor because of all the negative news about the company since its well in the Gulf of Mexico blew up in April 2010. As a result of the accident, the company has replaced top management. It has also sold assets, improved its balance sheet and refocused the business on its most promising sectors. Most of the liabilities relating to the accident have been taken care of, and I believe that investors are overestimating those that are still unresolved. You may have to be patient waiting for other investors to change their views on BP, but the stock pays you a generous 5% dividend while you wait.

CLJ: What’s one important piece of advice you think more investors need to hear?

GP: I have two, actually: be well diversified and be patient. Diversification is by far the best way to reduce risk in any portfolio whatever strategy you may be following. Patience is always important, but particularly with turnaround situations. It often takes longer than you expect for the turnaround strategy to take hold and to be recognized by other investors.

CLJ: What do you see as the biggest challenge in the market right now?

GP: It is very tempting for investors—particularly those who may have been out of the market for a while—to chase hot stocks that have been running up.

Inevitably, those stocks will stop running up and return to earth, causing a lot of pain for investors who chased them up. It may seem counterintuitive, but I believe that the best way to make money in the long run is to buy stocks that have been underperforming. If the company has a good core business and its problems can be fixed, the stock will eventually appreciate very nicely.

CLJ: Good advice. Before I let you go, let us get to know you better—what else do you like to do besides investing?

GP: I like to sail and grow vegetables. In some ways both of these pursuits are like investing. You are dealing with forces you can’t control, such as the weather, but you analyze whatever data is available and make the best decision you can.

CLJ: Interesting! Well, thanks for talking to me today and best of luck in our Top Picks for 2013 contest—not that you need it!

Wishing you success in your investing and beyond,

Chloe Lutts Jensen

Editor of Investment of the Week

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