If You're Hunting for Turnarounds

 | Dec 04, 2013 | 3:00 PM EST
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Before I move on from my overview of stocks in Value Line, there is one more section of the weekly report that I consider required reading. Each week, the publication issues a list of the stocks that its measurements calculate will have the highest three-to-five-year total returns. They may not fit my classic value definitions, but this list is one of the best hunting grounds for turnaround candidates and long shots I have found in my career. Applying a little common sense can help you find those beaten-up stocks that rebound and provide huge returns over the next few years. If I were a much younger man, this would be a much bigger part of my approach to investing.

EZCorp (EXPW) makes the list this week: Shares of the pawnbroker and short-term lender have tumbled from the mid-$20s to about $11. The company has had some issues with volatile gold prices, as well as continued problems at British pawnbroker Albemarle & Bond, in which EZCorp has about a 30% stake. During the recession, traders and the buy-a-story crowd loved this stock, and it traded as high as $38 in 2010. While the economy may be marginally better right now, there is still strong demand for pawn loans, car title loans and payday loans amongst the company's core demographic. EZCorp's expansion efforts should start to pay off next year.

The biggest problem remains in Albemarle and Bond. EZCorp has already taken a huge writedown of this investment, and it looks like they want out altogether. The company's representatives to the Albemarle board have resigned, leaving EZCorp free to sell its remaining stake without a conflict of interest. Albemarle and Bond is said to be searching for a buyer for itself, so once this misstep is behind EZCorp -- perhaps by next year -- earnings at the company should leap a lot higher. The stock could easily return to the mid $20s or beyond over the next few years.

Ion Geophysical (IO) is on the list as a potential turnaround, and I think the return potential here could be spectacular. The company makes seismic data-acquisition equipment used by seismic contractors and the oil-and-gas industry. Business conditions can only be described as horrible for the company --revenue has fallen, and Ion has posted losses for the last three quarters. The company has been increasing its data libraries, and it should see demand for its products reemerge sometime in 2014 and get the company back in the black. This stock could easily triple from the current price in the next few years.

I have owned Ion several times in my career, when it's seemed to be out of favor, as it does now. Each time, business has recovered enough to allow me to reap a substantial profit in a reasonable period of time. I see no reasons for this time to be any different.

LSI (LSI) makes the list, as the shares have started to recover from the lows of the year. This company is in the highly competitive industry of high-performance integrated circuit and data storage, and it has struggled to keep up with companies such as IBM (IBM) and Texas Instruments (TXN). As demand for circuits and storage picks up in the next few years, the company should be able to corner enough of the market to grow top- and bottom-line growth at a sufficient pace to drive the stock price higher.

LSI has a strong balance sheet and recently instituted a dividend. The stock may not be as exciting as the first two, but I would not be surprised to see the business and the stock price do a slow grind higher and at least double over the next few years.

Most investors ignore turnarounds, for the most part, even though there seems to be plenty of evidence that they should not. If the company is financially strong enough to survive, and if management is not criminally stupid, many of these fallen angels stocks will take flight again over a three-to-five-year period. If you are right more than half, the time turnaround investing can provide returns far in excess of the overall market. These stocks also will trade on the improving business condition and fundamentals -- and, often, they can rise strongly even in a bad market. I am convinced that having a few turnarounds in your portfolio can dramatically improve your returns. This weekly list from Value Line is a great place to search for them.

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