Some Turnarounds Have More Snap

Turnaround stock opportunities can vary widely. I put them in a couple of buckets, differentiating between top-tier companies and the rest of the lot. While top-tier companies offer a lower level of risk for the turnaround investor, the trade-off is lower prospective profit.

The metaphor of a rubber band is useful to illustrate my point. When premier companies run into operational problems, the "stock price rubber band" is not stretched as far as it is with other companies. Accordingly, when the stock price snaps back, the potential investment gain from top-tier turnarounds is not as pronounced as with other companies.

I've discussed a few top-tier companies in past RealMoney columns and Columnist Conversation notes. For example, Home Depot (HD - commentary - Cramer's Take) has increased 70% since I wrote a column two years ago judging the leading home improvement retailer to be better than Lowe's (LOW - commentary - Cramer's Take).

Not Stretched Enough in Top Tier

While I participated in the rally at Home Depot, one that I missed was Costco's (COST - commentary - Cramer's Take). Costco is a premier company, the leader in the warehouse retail category on every operational metric. It's easily ahead of runner-up Sam's Club, which is owned by Wal-Mart (WMT - commentary - Cramer's Take).

When Costco ran into operational headwinds one year ago, badly missing estimates, I told RealMoney subscribers that the stock was a "good buy" at $34. But I personally missed buying Costco, hoping the rubber band would stretch to my too-low target price of $30 per share. That was a mistake. Costco didn't come close to $30, and currently trades around $49.

What is the common link between top-tier companies that run into trouble? I think it is that while they get cheap, they never get damn cheap. The price rubber band stretches with premier companies, but not to ridiculous levels. In the cases of Home Depot and Costco, for example, each traded significantly below all-time highs, but not below a price-to-earnings ratio of 15.

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At time of publication, Alsin and/or ACM was long Wild Oats, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail].