Turnaround Stocks: U-Turn To High Returns

  Source: Investopedia

Weeding through beaten down companies to identify a turnaround stock can be a thorny situation. It's tedious and time consuming, and even if you feel you've done all your homework, the pick could still go bad. In this article we'll show you some harbingers of a turnaround situation that will help you isolate the flower from the weeds.

There are three root causes of corporate rejuvenation. They include: a sales jump, cost-cutting initiatives and new products. Let's take a closer look at them and some stocks that have turned around as a result of these changes.

1. A Sales Jump: While change at many public companies can proceed at a glacial pace, there are times when a company turns around on a dime to experience dramatic sequential or year-over-year improvements in sales.

A terrific example of just such a reversal of fortune can be found in an analysis of IBM (NYSE:IBM) in the mid 1990s. Prior to fomer chief executive Lou Gerstner's arrival on the scene, the computer giant was struggling. In fact, its product arsenal was downright paltry, and some investors questioned whether the company would be able to compete with the likes of Hewlett-Packard (NYSE:HPQ) and Apple Inc. (NYSE:APPL) over the long haul.

But Gerstner changed all that. Under his leadership, IBM introduced a slew of new products and focused increasingly on offering business services as well. In addition, he presided over a huge cost-cutting program that eliminated millions of redundant expenditures. This allowed the company to invest in future growth opportunities. 

The result of Gerstner's efforts showed through IBM's sequential and year-over-year improvement in net sales. In fact, on an annualized basis it grew revenue from $64 billion in 1994 to more than $87 billion by 1999, a major improvement for a company that was already among the nation's largest. Not surprisingly, the share price also increased during this time, from the $30 range to more than $100 per share by 1999.

 The lesson in this is to pay particular attention to companies that have shown marked improvements in sales, because it is a strong sign that better times - and higher stock prices - may lie ahead.

 

2. Major Cost-Cutting Initiatives: Even if a company isn't dramatically growing sales, it can still enhance shareholder value and drive its share price higher through aggressive cost cutting. Let's take a look at how Kimberly Clark (NYSE:KMB) managed to turn around its stock through this measure. 

In July 2005, the well-known maker of health and hygiene products announced plans to cut 6,000 jobs and sell or close up to 20 plants. Management said the cuts could save the company as much as $300 to $350 million annually by 2009. Perhaps even more importantly, it would free up resources so that the company could expand its business in China and focus on high-margin end products, such as diapers and paper towels.

Soon after this major cost cut, Kimberly Clark started to see some sizable savings. The stock reversed course and by March 2008 was trading almost $10/share higher than it did at the end of the 2005.

3. New Products in the Cards: Due to the after-effects of the tech bubble burst, a sluggish product pipeline and tough competition from companies like Microsoft (Nasdaq:MSFT), Apple's stock was struggling by late 2001.

Then along came a little product known as the iPod. While the iPod wasn't a sensation right off the bat, it was a solid product aimed at a very good consumer base, which helped it gain some valuable traction over its first few years. As new generations of the product hit the shelves - and everyone from celebrities to politicians were spotted with them - demand picked up quickly.

As of October 2007, the company had sold more than 120 million of the little gadgets, and it is a major reason why Apple is one of the top resurrection stories of the past decade. While not all new product releases will ultimately be a success, a new item often generates a lot of buzz in the investment community if it has the potential to drive the company's sales materially higher.

Bottom Line: Be on the lookout for one of the above catalysts at a struggling company, because they are often the first signs that a turnaround may be in the works. And, you don't have to get in at the beginning of a turnaround to profit, getting in on a rising company that looks to have long-term potential is still a solid investing technique.