Turnarounds Can Bring Rewards

 | May 28, 2013 | 1:00 PM EDT
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Some great investments can be found in stocks that are in the midst of staging a comeback, or in more appropriate terms, a turnaround.

Yet, there is an a truism with respect to turnarounds: Many never succeed at "turning" around. What you see happening is a long, drawn out process of stagnation.

When turnarounds do prove successful, however, it's often because there was a decent business to begin with that had somehow lost its way. When turnarounds fail, it's often because the business was doomed from the start.

Successful turnarounds include businesses with recognizable brands that have been around for a while but simply fell behind the competition. A successful turnaround can also include a relatively new business that is the leading innovator in its industry. It may have taken a step back but is capable of taking two steps forward. A great example here is Netflix (NFLX). Unfortunately for investors, the share price has come roaring back and has already priced the turnaround.

Yet some opportunities still remain out there, perhaps not as exciting as Neftlix but still attractive nonetheless. Wendy's (WEN) is a classic turnaround story of an iconic brand that fell behind McDonald's (MCD) and Burger King (BKW). But Wendy's is making its own adjustments as well as taking cues from the successful reinventions of both McDonald's and Burger King. At $6 a share, Wendy's shares are up 50% in the past year but shares could continue upward as the company continues its reimaging program and reinvents its menu.

Hewlett Packard (HPQ) and Dell (DELL) are the two big tech turnaround plays currently unfolding. Both are anchored by a leading brand but both have also reinvented that brand. Signs of progress are starting to sprout at HPQ. Shares are up over 100% in the past year but still remain way below where they stood before the business started deteriorating. Dell, at least according to Icahn and Southeastern Asset Management, remains well below its true value -- which is north of $20, according to its largest shareholders. At $13 and change, sprouts of progress will be enough to send shares upward.

The most intriguing turnaround, but perhaps the most difficult, is JCPenney (JCP). After falling to below $14 a couple of months ago, shares have advanced past $19 a share. They still remain well below the 52 week high of $32 and below the cost basis of its largest investor, Bill Ackman, who is behind the turnaround. George Soros recently bought in, although he's up a tidy 15% or so already. If Mr. Market believes in the reinstatement of the former CEO, JCP could be that rare case of a retail turnaround.

The success of turnaround investing is easily explainable. Poor performance can lead to a widely-inefficient stock price as investors rush for the exists. Such selling often creates a low quality asset with a such a low share price that the asset becomes an attractive investment.

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