Four Trends That Favor the Hounds

Do these numbers guarantee that you'll do better in 2004 with stocks like these than with those that led the market up in 2003? Of course not. There are no guarantees in investing.

But consider the way the cards seem to be falling for 2004.

Not all of the stocks on this list are equal, of course. I'd divide them into three groups.

Group 1: Mature Turnarounds

Companies like these are far enough down the restructuring path that investors can be reasonably certain that the effort is going to work. For example, about 18 months after the company emerged from bankruptcy reorganization, Washington International clearly has regained sufficient customer confidence to produce a growing backlog of engineering and construction work, including important security business. The stock still is likely to appreciate in 2004 -- $40 is a reasonable target price for a potential 18% gain, but investors shouldn't anticipate anything like the 132% gain the stock has racked up over the last 12 months.

Boeing, which has climbed off a 52-week low of $24.73 to gain 60%, also belongs in this group. That's largely on investor faith in the proven turnaround abilities of new CEO Harry Stonecipher. Long-term investors still can earn a solid return from that turnaround, but the quick bounce is gone. Add Scholastic, publisher of the Harry Potter series, here as well.

Group 2: Reasonable-Bet Turnarounds

Companies in this group have taken significant steps to implement a clear turnaround plan. Examples include Schlumberger's sale of the bulk of its Sema technology unit, a bad fit almost from the day in 2001 when the oil-services company overpaid to acquire the business, and the company's plan to sell a stake in its smart-card unit in an initial public offering in 2004. Those are all part of Schlumberger's plan to focus on its oil-services business. Investors can see the other side of that effort -- the reinvestment in that core business -- in Schlumberger's acquisition of 26% of PetroAlliance Services, a leading Russian oil-service provider.

Doubts remain in many investors' minds about the growth prospects for the oil-services sector. Yet with revenue up 14% over last year, according to Sanford Bernstein, and projected to climb another 10% next year, those doubts seem overblown. Plus, the doubts do mean extra profit potential: I think a reasonable target price for Schlumberger is $63 a share, about 25% above recent prices. In this group along with Schlumberger, I'd put HCA -- a current Jubak's Pick with a target price of $54 a share -- AK Steel and Plum Creek Timber.

Group 3: Still-Speculative Turnarounds

These companies are implementing turnarounds that are still at significant risk of failure -- EDS is one -- or are months, perhaps even years, from instituting changes that would make a successful turnaround possible. Disney and Merck fall into this category.

EDS has done all the right things by bringing in new management, changing its accounting to accurately calculate profit margins on new contracts and changing its business mix. But it remains unclear that this will be enough. EDS still suffers from old, large but unprofitable contracts, and it continues to face stiff competition to retain big accounts that have been targeted by aggressive competitors. EDS is in danger of losing its $7 billion contract to run the U.K.'s tax and national insurance system.

The prospects at Disney and Merck are equally uncertain, but for different reasons. There, managers who have been unable to fix problems are entrenched.

Although Disney faces major problems with its ABC television network, its theme parks and its flagship animated film business, CEO Michael Eisner is firmly in control of the company's board of directors. In fact, Eisner's power increased with the resignation of Roy Disney, his strongest critic on the board.

At Merck, similarly, CEO Raymond Gilmartin recently announced that he will stay two more years to groom his successor, even though under his regime Merck has been unable to build a pipeline of new drugs to offset those older products going off patent.

Stocks like Disney and Merck are turnarounds waiting to happen and are definitely undervalued at the moment. But right now it's impossible to predict when the new management necessary for a turnaround will get a shot at maximizing shareholder value.

The best hunting for most investors is in Group 2: It offers the best potential for solid returns in a reasonable period of time -- say the next 18 months. Group 1 stocks are more suited to quicker trigger fingers because they are closer to the end of major moves. And Group 3 names require lots of patience and slow, steady accumulation.

As always, do your own due diligence. But also remember to make your picks with your own investing style and time horizon in mind. Investing in turnarounds only works if you don't change your mind before the stock changes direction.