How to Find Turnaround Stocks

5 Tips on Finding Growth Stocks with Promise

In my Wall Street’s Best Daily earlier this week, “Grease Your Portfolio with this Turnaround Stock,” I briefly discussed the characteristics of turnaround stocks, citing Tim Lutts’ three criteria: capable management, a good plan and a revival of revenue growth. I also included a recommendation for a stock that we recently published in Wall Street’s Best Investments

Today, I want to dig a little deeper into what makes a company a possible turnaround candidate.

Turnaround Stocks: What to Look For

Let’s begin with Management. In most cases, weak management is the key that drove the company into a crisis. In some cases, if management is up to the task, it can admit the error of its ways, and set out to show investors, employees and customers that it can reverse strategies. But very, often, a restructuring of the executive team (or even the Board of Directors) is required in order to restore investor confidence.

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A Plan or Strategy must be defined, and with an accompanying timeline. One of the key elements of a good plan is managing cash flows—keeping a sharp eye on revenues and expenses, and cutting out the fluff, which may mean dispensing with businesses that are not contributing enough to the bottom line. As well, a new strategy will include ideas for additional revenue and profit opportunities—new products, services or markets.

In a few cases, the company’s problem may be due to its environment, where the “paint everything with the same brush” philosophy permeates. Case in point, after the tech wreck of 2000, investors shied away from technology stocks. And following the recession of 2008-2009, investors wouldn’t touch a financial company for years—even those that weren’t involved with the subprime mortgage markets. So when the environment changes, suddenly, companies that were distressed may soon find new footing, making them once more attractive to investors. This is often the case with large interest rate moves, which can have a dramatic effect on certain industries, like finance, real estate and cyclical businesses.

Low Price-Earnings Ratios are a good indicator of a cheap valuation, although, as I said in my last article, “sometimes a dog is just a dog.” But a low P/E is a place to start. It is simply the price of the stock divided by four quarters of earnings (usually the last four quarters, but different analysts and websites use different denominators, so make sure you are comparing apples to apples). Also, investors might want to look at a company’s price/book ratio, which is the price of the stock divided by the sum of its assets, minus intangibles such as goodwill, perceived brand value, etc.

Most stocks ready for a turnaround will be trading at low valuations because the market and investors have (hopefully, just temporarily) given up on them. In other word, very few investors are interested in the stock. However, you must also consider that the P/E or P/B may be low because a company has poor management, and doesn’t have a clue about turning its fortunes around.

A spike in revenues and/or earnings are good indications that a company’s turnaround may be working. Again, all the other elements must be in place, but if they are, and the company’s financials begin to perk up, that’s a good indication that a turnaround is underway.

To help in your search for turnaround stocks, I’d like to offer a few that we have recently included in our Wall Street’s Best Investments or Wall Street’s Best Dividend Stocks newsletters.

Three Turnaround Stocks to Consider

Turnaround Stock #1: Cirrus Logic (CRUS)

Contributor Nate Pile, editor of Nate’s Notes had this to say about Cirrus: “Though I will be forced to change my tune if the stock breaks below $50 in the days and weeks ahead (and despite how sharp the recent selloff has been), I have to say that I actually like what I see in the chart, as I believe it is a great example of the sort of short-term volatility that we’re hoping to see as part of our belief that we are, in fact, in the throes of a frothy, blow-off phase for the market.

“For its first quarter, Cirrus reported revenues of $320.8 million and net income of $42.9 million, or $0.64 per share, as compared to revenues of $327.9 million and net income of roughly $35.1 million, or $0.52 per share, in the same period a year ago. CRUS is now a strong buy under $52 and a buy under $60.”

Cirrus Logic (CRUS) is one of three turnaround stocks to consider right now.

Turnaround Stock #2: Sinclair Broadcast Group (SBGI)

John Dobosz, editor of Forbes Dividend Investor, recently recommended SBGI, saying: “Shares of Maryland-based television station owner Sinclair Broadcast Group (SBGI) have fallen following the company’s August 1 quarterly earnings report, which featured EPS coming in higher than analysts’ forecasts, but the company warning that revenue projections in the year ahead were weaker than original forecasts due to a falloff in advertising revenue from for-profit schools.

“Sinclair is also in the process of acquiring Tribune Media (TRCO), which would add 42 local television stations to the company’s portfolio.  Sinclair’s $0.72 per share in annual dividends is easily covered by $4.66 per share in free cash flow over the past 12 months, and August 30 is the ex-dividend date for the next $0.18 quarterly payout.

“In addition, the stock trades at significant discounts to historical valuations. Buy.”

Turnaround Stock #3: Kohl’s (KSS)

KSS was recommended by George Putnam III in his Turnaround Letter. George noted, “Retailer Kohl’s operates 1,157 department stores and several outlets along with its e-commerce website. It emphasizes apparel and home goods, with almost half of its $19 billion in revenues coming from higher-margin private label and exclusive brands.

“Like nearly all brick-and-mortar retailers, Kohl’s has struggled with declining sales as online competition accelerates. However, the company is seeing improving traffic to its stores, and its online sales are growing at nearly a 20% rate. It has a relatively fresh store base due to a combination of recent upgrades and new locations, has committed to a $250 million cost-cutting program and is seeing some success with various new marketing initiatives.

“The balance sheet is healthy, the dividend is well-covered by cash flow and management is committed to sustaining its dividends, which have increased every year since its 2011 inception.”

Each of these companies looks like a turnaround is a good possibility. But, please realize that investing in possible turnaround stocks is speculative, so make sure your total investments represents just a small portion of your portfolio.

Nancy Zambell

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