Last year's

Top-10 Turnaround Candidates have enjoyed considerable success. With an average gain of 49% this year, the portfolio has exceeded the performance of the

S&P 500

, which has slumped nearly 14% in 2001 as of Tuesday's close. Of the 10 picks, eight have returned at least 18%, and two,

Office Depot

(ODP) - Get Report


J.C. Penney

(JCP) - Get Report

, each have returned more than 110%.

Last time, I posted my Top-10 list as a two-part column. This year, I'm going to devote more time to explaining the analysis behind each selection, so I'm going to roll out two picks per column over a period of five weeks -- starting now.

A Few Caveats

First, a word of warning: Your favorite stock probably will not make my list. Like last year's candidates, this year's won't include any tech or big-cap stocks. All of the fallen stars from the last cycle, such as


(CSCO) - Get Report



(ORCL) - Get Report



(INTC) - Get Report



(SUNW) - Get Report

, have failed to make the list again.

My first theme for the 2002 turnaround list is straightforward: Buy small stocks. By a wide margin, large stocks dominated the market from 1995 to 2000. My study of market history indicates that outperformance cycles of small stocks last from three to 10 years. I think a multi-year small-cap cycle is already under way. Accordingly, most of the Top 10 are small-cap stocks -- or at least smallish mid-cap stocks.

The second theme is an emphasis on plain vanilla companies. In a word, my picks are boring. A lot of investors fail to distinguish a good investment from a good story. If I find a company with impressive products or some dazzling new technology, maybe I've found a good story. But that doesn't mean it's a good investment.

Making good stock investments requires finding companies with a wide divergence between the business value and the stock value. Below are a few good investments. They're boring, they're small-cap and most importantly, they're in turnaround mode.

Bowne & Co.

As a turnaround investor, I like to invest in companies that are unloved, unappreciated and undervalued. My first pick fits the bill nicely. Not covered by a single major brokerage analyst,

Bowne & Co.


is a $370 million small-cap with more than $1 billion in sales. It is the leading financial printer in the world and, happily, very profitable. As you can see from the chart below, this unloved $11 stock is down a lot from its all-time high above $22.

Where's the Love?
Bowne has seen its share price slide

Bowne's revenue base is made up of financial print (70%), outsourcing (22%) and globalization (8%). Only five years ago, financial print was 100% of the business. The outsourcing business is growing particularly fast, with revenue in this division up 24% so far this year.

The financial print business -- such as prospectus printing for initial public offerings and mutual funds -- is currently depressed, but recent action in the brokers suggests a turn is coming.

I wrote a

column in early October about the compelling undervaluation of the brokerage group. Since then, it's made a big move (up about 25%), especially the big brokers such as

Goldman Sachs

(GS) - Get Report


Merrill Lynch



Morgan Stanley


. This is one of several signals that the investment banking business will be improving in 2002.

The brokers have moved in a big way, and a clear beneficiary of an improvement in investment banking -- via its dominant position in financial print -- is Bowne.

Prime Hospitality

Stock values in the travel industry reflect the worst industry conditions in more than a generation. That spells opportunity for investors.

Prime Hospitality


is a $450 million small-cap stock. It operates 235 hotels in 33 states under two brands, Amerisuites and Wellesley Inn and Suites. As you can see from the chart below, this $9.90 stock is off a lot from its all-time high of $23.

A Prime Opportunity?
Prime Hospitality could be a good buy for patient investors

Prime has a history of solid profitability, earning more than $1 a share from 1998 to 2000, but the economy's decline in 2001 and the impact of terrorism on the travel industry will hurt profits this year and next.

The question for the patient turnaround investor is simple: What is Prime's earnings potential when the economy rebounds and the travel industry returns to normal, say, in 2003 and beyond? On the basis of Prime's normalized profit margins of roughly 11.5%, this company has earning power of at least $1.40 per share. A reasonable price-to-earnings ratio for this company is 13 to 15 times earnings, suggesting a target price range of $17 to $21 in a couple of years.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, Alsin and/or ACM was long Circuit City, E*Trade, J.C. Penney, Hasbro, Office Depot, TRW, UAL, Bowne and Prime Hospitality, although holdings can change at any time. 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