It has been a very long time since I wrote a column recommending stocks. Too long. But you know my investment process by now: Look for stocks that are down a lot, cheap and have decent fundamentals. Unfortunately, very few have hit my buy screen for quite some time. I rarely violate that process, and it has kept me silent. But now things have changed. The "new bull market" ads have disappeared and cavalier forecasts of 30% returns have evaporated. The talking heads have tempered their enthusiasm. The tech stock bullies' chest-thumping on national TV has been replaced with fidgety defenses of their positions. Wall Street analysts slash ratings and stock targets, and jockey over the most bearish call on the tech cycle. And this is good. For the first time in over a year, I can recommend shares that fit my investment discipline. The frustrating churning of the equity markets has generated solid opportunities in a few sectors: financials, technology, consumer goods and health care. With an economy in recovery and still-healthy profit growth, I am particularly interested in economically sensitive technology turnaround situations. I believe more stock price leverage exists in this sector than conventional industrial and raw material stocks, which already discount much of the recovery. Here is my primer for turnaround investing.
The Turnaround Challenge
For many investors, one of the most frustrating investment concepts is handling a company's stock in a turnaround situation. Distressed fundamental situations often get much cheaper and take longer to resolve than investors anticipate. But once the market acknowledges a turnaround situation in progress, the shares become and remain expensive, well ahead of the actual turnaround process. As challenging and irritating as turnarounds can be, they can also be very lucrative. Let's take Tyco ( TYC) as an example. Tyco's well-documented management and fundamental problems surfaced in 2002. The shares plunged from the $60s to under $10 in by June of that year as profits dropped some 50%. The stock traded in a single-digit price-to-earnings ratio and was universally despised, especially by the shorts who maintained an active journal of the company's misdeeds and potential failure. Clearly the stock got much cheaper than many value investors expected it to.