Melvin: Looking at Long Shots and Turnarounds

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Each week when I go through the current edition of Value Line's newsletter, I look over the list of stocks that the investment research service says have the highest three-to-five-year annual returns. While these stocks are not all classic deep-value candidates, this collection of long shots and turnarounds uncovers some fantastic opportunities.

I dedicate a small portion of my portfolio to these picks, but if I were a younger man, I would concentrate much more of my attention on these special-situation stocks. While everyone else was waiting for new Fed Chair Janet Yellen this morning, I thought it would be more productive to take a longer look at some candidates that could give us returns measured in multiples rather than percentages.

Fairway Group Holdings (FWM) is a delightfully broken IPO. The company came public last April at $13 a share. Naturally, the market loved the idea of upscale grocery stores in the New York City market, and the stock jumped up as high as $29. It has been pretty much downhill since then, as results have disappointed, and the CEO who drove much of the success at Fairway stepped down. The company currently has 15 stores and plans to open three to four stores a year.

Although Fairway may face competition from Whole Foods (WFM), I believe the New York City market is big enough for both of them. The next few quarters will probably be weak, but if Fairway enjoys any sort of long-term success at growing the store base, this stock could easily gain 100% or more over the next few years. It is definitely a long-shot stock but one that would seem to have enormous payoff potential.

I have talked about Apollo Investment (AINV) as an alternative income selection. According to Value Line, Apollo is also a candidate for huge total returns over the next few years. The business development company has a diversified portfolio of investments in 93 companies. A slowly growing economy should lead to both improved portfolio performance and higher demand for non-bank financing in the middle-market companies it favors. Its relationship with one of the largest private-equity firms in the world, Apollo Global APO, is also useful when it comes to sourcing deals.

A combination of being kicked out of the S&P indices and an add-on stock offering has pressured the shares recently, and this is a great entry point. The stock is trading right at net asset value and currently yields a very nice 9.41%. Insiders have been buying shares on the recent dip, and so should we. This business development company looks to have home-run potential for patient investors.

Weight Watchers (WTW) is another company that has seen very poor short-term results. It has lowered guidance and eliminated the dividend, and investors have not been too receptive to the shares. The stock is off more than 40% in the past six months. Weight Watchers is a pretty well-known brand, and it has been advertising and promoting very aggressively in 2014.

The March comparisons could be brutal for Weight Watchers, and we may see a final smash-down of the stock before it is all over, but from a long-term perspective, there is decent recovery potential in the stock. About 100 million people in the U.S. want to lose weight, but only a few million have tried a commercial service such as Weight Watchers to aid their efforts. That should increase as the economy improves, and when the jobs market recovers, we could see a significant jump in the number of people who are willing and able to pay for weight-loss assistance.

The list has a lot of old favorite long shots and turnarounds that still qualify. ACCO Brands (ACCO) is one of my favorite long-shot picks, and it still has significant long-term potential. I am a big fan of EZCORP (EZPW) and its recovery prospects as well, and the stock is still on the list of potential top performers. So is ION Geophysical (IO), the seismic data concern I have mentioned.

Long shots and turnarounds should be at least a small part of most portfolios. Younger, more aggressive investors should consider devoting a significant portion of their efforts to uncovering these potentially powerful stocks.

Editor's Note: This article was originally published at 1:30 p.m. EDT on Real Money on March 19.

At the time of publication, Melvin was long AINV and ACCO, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.

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