Look for Long Shots and Turnarounds

 | Apr 01, 2014 | 5:30 PM EDT
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In addition to constantly searching for safe and cheap stocks, I always spend a little time each week looking for longshots and turnarounds for part of my portfolio. While not necessarily classic value stocks, these companies have the potential for huge returns over the next few years as their business improves and the market begins to recognize their potential.

These types of stocks can outperform regardless of what the market does because the share price performance tends to be driven by events and announcements more than by market movements. I usually have a few of these in my portfolio and I encourage my kids to devote a substantial portion of their efforts to long shot and turnaround stocks.

For the past two years, I have kept track of those stocks and they have done fairly well. The 2012 crop was up more than 50% on average and the 2013 candidates have basically matched the market's impressive rise. What's really impressive about the 2013 numbers is that about half the portfolio was just purchased in October or later. Names chosen early last year include SuperValu (SVU), Felcor (FCH) and Lionsbridge Technologies (LIOX), which have turned into moon shots already.

To find these stocks, I use various screens and research services, including my favorite hunting ground, The Value Line Research Service. The S&P Capital IQ Stars Ranking system has also delivered some solid winners. I look for stocks priced in the single digits with the top two stars' ranking to find those that have long shot potential. The following names are some of the intriguing stocks I found this morning.

With a four-star rating from the research service, Sonus Networks (SONS) makes the grade. The company makes provides switching equipment and software solutions that enable voice services to be delivered over packet-based networks. The company should see decent revenue and earnings growth driven by their entry in the market for Session Border Controllers, a device used in Voice over Internet phone (VOIP) systems to control the signaling and media streams. The company also made an acquisition that should close soon that adds to their cloud, mobile, and multimedia service portfolio. The company appears to be well positioned in what should be a fast growing market in the next decade.

Synovous Financial (SNV) is a regional bank based in Georgia that has made enormous strides to improve their condition since the financial crisis. Although most of their 260 branches are in Georgia they also have locations in Alabama, South Carolina, Florida, and Tennessee. The bank currently has a little over $26 billion in total assets. The company did a stock offering last year and paid back the troubled asset relief program (TARP) preferred stock and have disposed if problem loans. Non-performing assets have dropped from 3.79% of total assets to just 1.91% today. Before the financial crisis this stock traded in the mid tens and patient investors could see the stock recover much of that ground over the next several years.

With 1.2 million subscribers EarthLink (ELNK) has been something of a perennial long shot. The company is one of the largest independent Internet service providers. As the residential internet market has become more and more competitive the company has made some acquisitions to increase their presence in the market for business related services. The company has also been selected by several cities and towns to provide Wi-Fi service to give free high-speed Internet access to the public and for business use. The company generates a decent amount of cash flow and has used some of it to pay dividends and the stock actually has a very nice 5.8% yield at the current price, so you are being paid to wait for the turnaround to fully turn.

Not all long shots or turnarounds work out. Some languish for a long period of time without a lot of improvement in their business conditions or stock prices. A few may just go away because management just cannot make things work. But those that do work tend to give spectacular returns with many of them doubling, tripling and more over a few years.

If you bat about 50% in picking turnovers, you should easily beat the market. If you do better than that, you will compound your money at a very high rate. The math is too compelling to not have a few long shots in your portfolio.

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