From The Motley Fool
Turnaround stocks represent companies that are on the verge of a possible u-turn, or a revival of their fortunes. Due to their inherent volatile nature, they are pure contrarian plays and are therefore not ideal for the fainthearted. While they lure investors with a possibility of monumental returns in the long run, they can also turn sour -- as in the case of investors who bought into the US Airways’ turnaround story in 2003 and ended up with enormous losses when the company filed for another bankruptcy just 12 months later.
These stocks are generally difficult to judge based on conventional metrics, such as price-to-earnings ratio (P/E) and PEG ratio, since either they are not making any profits or have just started eking out some income as their shares rally – which often results in a negative or an unusually large P/E ratio.
I believe that as a general rule, investors shouldn’t bet on a company’s turnaround which:
a) has a high debt-to-equity ratio, i.e. anything above 70%;
b) is operating in a dying industry
Companies that have reasonable debt levels, have delivered a history of solid performance in their ‘golden years’, and are operating in an industry with huge potential are a much safer and attractive bet. The three companies mentioned below could represent significant upside but potential investors should note
