In his famous book, "One Up on Wall Street", Peter Lynch describes the characteristics of a potentially profitable "turnaround play": It's normally a company that performed well in its ongoing business, usually in the retail industry, then something went wrong, normally in the industry as a whole, and the company, along with its stock were thrown to the sidelines, usually to the arms of chapter 11.
Then, some major positive fundamental event occurred within the company, which changes the company from top to bottom.
When times get better, the stock of such a company could make a good turnaround play because management (hopefully) turned the company into a much leaner, debt- reduced, highly efficient company. Hence, it is likely to outperform the market when the sun begins to shine. A turnaround play, Lynch adds, is a candidate to potentially become a 10 bagger for the investor.
There are two stocks that come to mind when discussing current candidates for turnaround plays in today's market:
1. The first ultimate candidate is General Motors (NYSE:GM), the global automaker. The company took a hard hit in 2008, was forced to file for bankruptcy, and reemerged as a much leaner, more efficient company that wishes to relive its days of glory.
At the beginning of 2011, GM reemerged with a much discussed launch of an IPO, surrounded with a lot of hype and commotion, and the stock price later peaked at $40 a share. In the months that followed the price was drastically cut only to trade at ~20$ today.
Some basic current valuation metrics for GM:
- Forward P/E of 5.5 for the year 2012, which implies an earnings yield of 18%.
- PEG (price to earning's growth) of 0.43. Lynch is particularly fond of this metric and he believes that it is a key to finding potential 10 baggers. He likes companies that trade for a PEG<1 because it implies that an investor can buy their potential growth on the cheap. In GM's case, it is currently half that metric.
- Price/Sales ratio of only 0.2. This ratio serves as a common thread across the retail industry and serves as a better indicator than the Price/Book ratio.
Considering the above valuation metrics, GM seems ripe for a strong upside increase in the years to come.
2. The second candidate is Charming Shoppes Inc. (NASDAQ:CHRS). Charming Shoppes, Inc. operates as a specialty apparel retailer primarily for women in the United States. The company operates retail stores and related e-commerce Web sites under the Lane Bryant, Fashion Bug, and Catherine's Plus Sizes brand names.
Charming Shoppes did not prepare well for the 2007-2008 crisis. Despite its relatively strong brand names, it lost a lot of money and saw the price of its stock plunge from $13 to around $3 were it is today.
Since then, Charming Shoppes has drastically cut its expenditures: It engaged in a store closing program where it closed more than 150 stores of the chain. It also put a strong emphasis on its e-commerce business to make it compatible with other e-retailers.
Some basic current valuation metrics for CHRS:
- No P/E exists for CHRS because the company is still losing money. It is expected to return to profitability next year.
- PEG (price to earning's growth) of 18.5. Again, this metric is extremely high because CHRS barely has any earnings/ earnings growth.
- Price/Sales ratio of only 0.2. Similarly to GM, the company also presents a favorable metric on this scale.
It is worthwhile to note that in contrast to GM which folded its cards and went for chapter 11, Charming has never completely stepped out of the game. Hence, its recovery is likely to take a longer time and be a more frustrating process.
I believe that a long- term investment in either one of those companies could prove to be a very good move.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.