Investing in Turnarounds

In the aftermath of the worst economic recession in nearly eighty years there are a lot of companies that are just putting themselves back together. The prime example was the company that once was the world’s largest corporation and the world’s largest auto maker. Things got so bad that General motors filed for bankruptcy and required a government bailout to stay in existence as a company. GM came out of bankruptcy. At the beginning of 2012 its stock sold for under $20 a share and now it sells for $35 a share. This brings up the topic of investing in turnarounds. Investing in turnarounds does not necessarily mean investing in companies that went broke. It can just be investing in companies that are displaying growth and vitality after a period of stagnation. For the long term investor interested in profiting by investing in turnarounds there are a number of things to look for. Some of these opportunities may be the most solid opportunities in today’s value investing.

In an improving economy many companies may seem to have a new lease on life. However, the same fundamental analysis that guides all long term investment should apply when investing in turnarounds. If the company is showing a profit it is important to understand where that profit is coming from. Is the company increasing its cash reserves? If it once paid dividends is it paying dividends again? A company that increases cash flow by selling assets may be trimming down and getting rid of obsolete aspects of its business. However, the investor should not be fooled into thinking that this sort of cash flow represents a turnaround. The company needs to be improving products, widening markets, and profiting from sales.

Big companies like General Motors, historically, are dividend stocks, as well as value opportunities. If GM continues its recovery investors should expect to see quarterly dividends resume. They should also expect to see the company’s products start to reclaim market share from competitors. In the case of GM this means Toyota, Ford, and to a lesser degree other automakers. Of course, once this is accomplished, the company in question will have a stock price commensurate with its success. The basic idea of investing in turnarounds is to invest before the turnaround drives the company’s stock price up. A useful clue as to what others with a vested interest think of the turnaround is if the turnaround company can get credit. In the case of GM it secured early on a $5 billion line of credit to assure constant cash flow. And it started making money fairly quickly once it was out of bankruptcy. Considering how tight banks had become in offering credit early in the recession this was a vote of confidence.

Investing in turnarounds is like investing in growing companies. The investor will want to asset how much market penetration the company will be able to accomplish and to what degree it will be able to profitably price its products. In the case of a large company accomplishing a turnaround there will always be a limit to how far it can recover and grow.

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