Revisiting the Top-10 Turnarounds

Working with turnaround stocks has always been fun for me. It's analogous to treasure hunting, with a similar level of excitement whenever a gem or two is found. Six months ago, I posted my list of turnaround gems and suggested that investors back up the truck and load up on these unusual values. Take a look at that list of turnarounds and how they've performed after two quarters.

Top-10 Turnaround Performance Here's how these stocks fared, as of Tuesday's close
Stock	Symbol	Cost	6/26 Close	Gain
Circuit City	CC	$10.80	$16.99	57.31%
UAL	UAL	35.88	32.00	-10.81
Office Depot	ODP	6.94	9.10	31.12
J.C. Penney	JCP	10.25	25.45	148.29
Raytheon	RTN	27.50	29.02	5.53
TRW	TRW	36.38	40.93	12.51
Hasbro	HAS	10.06	14.54	44.53
Georgia Gulf	GGC	15.00	15.02	0.13
E*Trade	ET	7.34	6.37	-13.22
H.B. Fuller	FULL	40.31	48.80	21.06
TOTAL				29.65%

With more than 7,000 mutual funds out there, I'm surprised that I can't find a turnaround fund. Without a turnaround fund or index to compare with my own Top-10 list, I contrasted the Top 10 with the S&P 500 and the Dow Jones Industrial Average. I've included performance for each three-month period (the first and second quarters) and for the six months since the date of publication.

Beating the Indices Turnaround stocks handily outpaced the major market measures
	Dec. 28	March 28	First-Quarter Return	June 26	Second-Quarter Return	Six-Month Return
S&P 500	1334	1153	-13.57%	1217	5.55%	-8.77%
DJIA	10,869	9785	-9.97	10,500	7.31	-3.39
Top 10			10.96%		15.83%	30.11%

Before I review the stocks that make up the Top 10, here's a summary of the principles I used in formulating the list:

• Buy Cheap: Let someone else chase the highfliers -- the hyped, expensive companies that are supposedly going to change the world. There's nothing wrong with boring and cheap. The principal advantage of buying cheap stocks is that if you are wrong and a turnaround doesn't occur, you can exit the stock near your purchase price.

• Look for Catalysts: Try to identify changes at a company that will facilitate unlocking value.

• Consider the Market Backdrop: As I said in my original Top-10 column, you can't simply buy "wonderful companies selling at giveaway prices without reference to the market backdrop." So, against the tech/telecom speculation of the last cycle, I limited the Top 10 to plain-vanilla stocks.

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Office Depot (ODP Quote)

I continue to expect $12 to $18 next year in my favorite Top-10 stock, Office Depot. Easy earnings comparisons start later this year, but my attention is focused on 2002. All we need is a bump to the economy to give this stock a substantial boost.

UAL (UAL Quote)

I tend to be a very placid, patient investor. You won't see me blink just because one of my stocks pops up or down 10% in a day or two. But UAL is causing me more than a little agitation for one simple reason: It is the single worst-managed company that I can think of.

Its merger with US Airways (U Quote) makes no sense at all. During good times, both UAL and US Airways earn comparable operating margins. Why, then, is UAL, with a $2 billion market cap, intent on paying more than $6 billion to acquire US Airways when US Airways has only half the revenue base?

The recently announced plan to take on Warren Buffett in the corporate jet time-share business is just as silly as the US Airways merger. It will encumber UAL with billions in new debt, while its ability to earn reasonable margins is very much in doubt, considering the high cost structure.

If UAL were a well-managed airline, like Continental (CAL Quote) or AMR (AMR Quote), comparable operating performance would yield a current stock price of roughly $70, or more than double the current quote. But with management that seems interested only in expansion while current operations are inefficient and ineptly managed, investors are advised to look elsewhere. Northwest Airlines (NWAC Quote), Delta (DAL Quote), AMR and Continental are all better alternatives in this sector.

I'm keeping UAL on the books for my Top-10 portfolio. I made the mistake of overreaching for this too-cheap stock, and I'm going to live with the consequences.

H.B. Fuller (FULL Quote), Georgia Gulf (GGC Quote)

We need a better economy to make a decent profit on my chemical companies, Fuller and Georgia Gulf. Cost trends are improving at both companies, but revenue needs to pick up to complete the picture. I intend to hold both stocks for at least another year.

Raytheon (RTN Quote), TRW (TRW Quote)

Defense industry stalwart Raytheon is the most conservative stock of my Top 10 and is still a solid buy. TRW, with businesses in defense, technology and auto parts, needs a stronger economy to fully realize its considerable profit potential. I continue to think TRW can double in value in the next cycle.

Circuit City (CC Quote), J.C. Penney (JCP Quote), Hasbro (HAS Quote)

My three biggest winners still have a lot of work to do in improving their businesses. A lot of the anticipated improvement is already in their stock quotes. But I'm not selling and would buy more on pullbacks.

E*Trade (ET Quote)

At current prices, E*Trade has the most potential upside of all of my turnaround picks. I can easily see $15 per share, or more, in the next year or so if the market improves. By every metric I use, E*Trade is selling at a price that should raise eyebrows. Its diversification strategy in banking has been a big success, and other fee-based services are paying off as well. The international trading platform is unique and valuable and is given no credit in this market environment. With dramatically curtailed advertising, its earnings could be surprisingly strong in the next cycle.