There you will find a young Steve Reitmeister doing a summer job for his father. Sure I was trying to earn extra spending money. But, more importantly, I was a budding young capitalist eager to learn about investing in stocks. So who better to learn from than my father, a seasoned Certified Financial Planner.

 

So dad pulls out the, seemingly 50 pound, hard copy Value Line Investment Survey binder. He reviews the basics with me. Such as understanding that owning stocks is about taking an ownership stake in the company. And the healthier the company and the more earnings it generates the higher the stock price will go. He then leaves me for a while to do some research on my own. 

 

I was immediately drawn to the valuation section for each stock. In my mind it made no sense to buy a stock that they only expected to go up 30-50% when some had the potential to go up 100, 200 even 300%.

 

My Dad tried to explain to me that they are discounted for a reason. Most of them were troubled companies producing poor earnings reports and suffering from declining stock prices. This made them risky investments and perhaps should be avoided.

 

No matter how hard he tried I could not be swayed. I wanted the chance at the higher potential return. Right then and there, it was clear I was a turnaround investor.

 

The story since then is one of some glorious successes (buying Amazon (AMZN) at $8.50 and Priceline (PCLN) at $25 after the internet bubble burst). But also a story of some shocking failures (watching shares of @Home and CMGI go from bad to non-existent).    

 

So the purpose of this article is to share some lessons learned over these 31 years with other investors who enjoy the thrill of profiting from a great turnaround story.  

 

 

There are many ways to invest successfully. Yet the appeal of the turnaround is broad based. That’s because no one will pat you on the back for buying an obviously good stock like Apple (AAPL) at $250 and selling it for $300. 

 

The joy of the turnaround story is that it’s often a discarded or unknown stock that no one else wants to touch. And when it goes up you get great satisfaction in the “I told you so” moment when you share the story with others (Many of whom didn’t take your advice in the first place. Shame on them ;-)

 

But more importantly, there is great satisfaction in the outsized returns that occurs when you guess right on a previously neglected stock. And that is the best reason of all to actively seek out these turnaround candidates.

 

 

The one thing that all my turnaround failures have in common is that I got in too early. Meaning I was buying in on the way down, hoping and praying that the turnaround would take place. Too often the turnaround did not materialize and my hard earned money was washed down the drain.

 

So the key is to have the patience for the company to show you undeniable proof that the turnaround is occurring. The clearest form of proof is when the company delivers a big positive earnings surprise that Wall Street analysts fawn over with greatly increased earnings estimates for the future.

 

Yes it’s true that the stock will jump on that news and you will not grab the stock “exactly” at the bottom. However, your entry point will be plenty low in the grand scheme of things. Plus you have now GREATLY increased your odds of being in a winning and timely trade.

 

 

You are bound to discover that a turnaround story can take place in any industry with companies both big and small. However, the best returns will come from buying the stocks that have the highest growth rates. That is because once the turnaround takes place the PE will start to rise from abnormally low levels. The higher the growth rate of the firm the more the multiple will expand and the greater your final return.

 

My two previous success stories of Amazon and Priceline prove out my point. These stocks are up 2000% and 1500% respectively since I bought them nine years ago. That’s because they are still experiencing the phenomenal growth associated with being internet ecommerce leaders. However, we all know I would not have fared as well if I invested in more pedestrian stocks like a phone company or bug exterminator.

 

Long story short…focus on growth stocks for the best turnaround profits.

 

 

 

Not every stock whose price has gone down is a bargain. That is become stocks have so much premium in their share price that it takes a long time to squeeze out the excess after the bad news hits. For other companies it’s not really a bargain because future estimates keep slipping faster than the share price decline thus making the PE actually rise.

 

Given the increased risk inherent in turnaround plays means that you should be buying at a discount to peers to make it worth your while. PE, PEG and Book Value are all useful tools. But certainly consider the lesser used Price to Sales ratio which quite often unveils the best opportunities.   

 

All of the above advice will help you select more stocks that will be turnaround winners. But even if you followed every lesson to the letter you’d still discover that this is one of the riskier stock investment approaches. So do not dedicate all of your money to a portfolio filled with turnaround candidates. Better to just have two or three at a time that fit well into a well diversified portfolio.

 

Simply no one knows for sure what the market will do tomorrow, next week or next month for that matter. But the further out you go, the clearer you can see what will happen because the movement of the market over time will be based on fundamentals. And right now the fundamentals are clearly improving as we can see from measures like corporate profits, GDP or even the jobs picture that is now turning around.

 

The more we stay focused on these fundamentals the more profitable we will be. And the less likely we will be to try and figure out what the market will do in the short run. That is the toughest game in town.

 

Turning back to the fundamentals we got a very nice Jobless Claims report Wednesday showing 435,000 new claims versus the 450,000 estimate. Better yet, this makes 2 out of the last 3 weeks coming in under 450,000. Combine this with the positive readings from the October Employment report and the dots are starting to connect towards real improvements in the job market.

 

No, unemployment in America has not been solved. But we are starting to make a turn for the better. Every step in that direction helps the cause for economic growth, corporate earnings and stocks. And that is the fundamental reason to stay invested right now.

 

(For more insight on the fundamental case for the stock market at this time, then check out my recent article; 4 Reasons Why Stocks Are Ready to Make New Highs)

 

 

 

Lower bond rates to raise inflation is like having a war to create peace. Because higher inflation begets higher bond rates. Seems that the bond vigilantes are on to him. Better stock up on TBT to profit as the 30 year bond rally comes to an end.  

 

McDonalds is one of the few companies that never really got hammered during the Great Recession. Their profit growth has been steady as she goes for 5 years plus and no wonder shares keep pressing higher.

 

Earnings estimates for next year continue to rise with many analysts calling for more than $2 per share. That means that SOL is only trading at a PE of 12. Quite modest given the growth prospects. My original position is just under $8 per share. But on this recent dip I am loading up with a bit more. I think that $16-19 is a reasonable 12 month target. (Note that some brokerage firms are looking for up to $23)
 

For a long time the shorts were ganged up on this stock with well over 10% shares shorted. Yet quarter after quarter PCLN just kept banging out huge earnings surprises. Many shorts have thrown in the towel on the ride up from $200 to $400+.You gotta laugh at anyone still hoping for this stock to implode (just not going to happen).

·         Jumped in at the peak

·         Jumped out too late

·         Bought falling knives

·         Doubled down on losers

·         You name it, I probably did it.

 

By the time I joined up with Zacks Investment Research in August 1999, I had eradicated most of those bad habits. But as Len Zacks and his brother Ben pointed out…I had a lot to learn.

 

What they taught me is that, indeed, earnings estimate revisions (EER) are the most powerful force impacting stock prices. And nothing captures that power more than the Zacks Rank rating system as proven by its +27% per year annual return.

 

The timing of this profound investment message could not have been better for me. As the stock market bubble popped in 2000 I started to apply this new investing approach. So even though the market tumbled that year I actually gained +16% in my personal account.

 

Was I hooked? Heck yes!!!

 

Each year since my knowledge and passion for this approach has grown. And there is nothing I like more than to share the wisdom of this investing strategy with others. My goal today is to spread some of that wisdom on to you so you can also enjoy great investment success in the years to come.  I’m going to do that by listing…

 

 

1)    The Most Fundamentally Sound Metric: There are so many different websites, magazines, books, TV stations etc. dedicated to investments. The amount of information overload is so unbearable that most investors walk away horribly confused about what is truly important to achieve success. So let me simplify the matter for you so you can push away all that noise and nonsense in the future.

 

 

Read that line again so it really sinks in. The reason it’s true is from the basic fact that when you buy shares in a company, you are actually buying a percentage ownership stake in that firm. And if you are the owner of a company, big or small, then the single most important metric to gauge success is how much earnings are generated.

 

If profits go higher than expected, the share price will rise. Conversely if profits go lower than expected, the share price will come down as well. The stock market has always worked on this premise and it always will. And nothing captures the essence of this notion more than earnings estimate revisions.

 

 

2)    Applies to Every Type of Investor: Because all stock price movements can be traced back to earnings, it follows that earnings should be at the heart of every investment decision. But that is not the same as saying that earnings are the ONLY thing to consider when selecting a stock. That is just the starting point. From there, each investor can layer on other concepts such as value, growth, charts etc. to find the stocks that fit their unique approach.

 

My favorite analogy for this is to say that earnings are to stock investing as flour is to baking. That’s because nearly 100% of baked goods include flour in the recipe. What makes each item unique and delicious is the rest is what you add into it (sugar, flavorings, nuts, fruit, butter etc). Each way works out well, but each starts with flour to make it all come together. So you can apply other factors on top of earning and estimates to make it suit your unique investment tastes as well.   

 

 

3)    It WORKS!: When you put the philosophy and analogies aside, earnings estimate revisions simply work. This is clearly proven by the market-crushing +27% average annual returns of the Zacks Rank since 1988. Through up and down markets it has provided extraordinary, life-changing results for investors. I can certainly testify that is true for me. So I know it can do the same for you too.

 

 

On Seeking Alpha my firm, Zacks Investment Research, has created a free app for you to see how well your stocks stack up in terms of Earnings Estimate Revisions. Just to get you started, here are some of my favorite EER stocks and their ratings in the Zacks App.

 

 

 
Get Your Own Free Zacks.com App on SeekingAlpha

 

 

 

When you consider this landscape, it’s no wonder the stock market is more volatile these days given all the different forces at work that drive the varied investor decisions.

 

So let me provide you something to help cut through the clutter and make more profitable investment decisions.  The largest single ingredient followed by the largest number of investors is earnings. In particular, earnings estimates. So the more you focus on these concepts the better off you will be.

 

Why’s that? Because institutional investors still rule the market. These money managers come to the play every day with trillions of dollars to spend. Meaning they have the greatest ability to change the shape of the market or the plight of any individual stock.

 

I am not implying this is a homogenous group of people who all make decisions the same way. They too follow many different investment strategies. But by far the most common thread between them is their belief in earnings.

 

That’s because most money managers are former stock analysts. And most stock analysts are Chartered Financial Analysts (CFA’s). These guys get drilled on the fundamentals of investing. In particular concepts like the Dividend Discount Model or Discounted Cash Flow model for valuing stocks. In a nut shell, these models work like so:     

If the present value of a company’s predicted future earnings stream is higher than the current price than more people will buy the stock.

So the main ingredients in this model are earnings estimates and the discount rate. As for earnings estimates if they go up, then the fair value of the stock goes up (and visa versa)

 

As for the discount rate that is the risk free rate plus a premium for taking risk in the stock market.

 

Given that earnings are still on the rise for most corporations and the discount rate is dropping (because the risk free/Treasury rate is near historic lows) is the #1 reason for the recent market rally. The good news is that if this earnings season meets or exceeds expectations, then we will continue to rally.

Sometimes it is that simple.

 

 

 

There are so many things to love about Apple. Here is one aspect that is little talked about, but can certainly help one appreciate how much gas is left in this growth engine.

There is so much focus on iPod, iPhone and iPad. Yes, they are revolutionary products and each industry leaders. But the real long term growth path for Apple is selling more computers. Meaning the computer market is still the largest and they have a very small slice of it.

With more customers buying their other "i" products, these people are now increasing their orders of desktops and laptops from Apple too. Just imagine if they could grow their market share to 15-20% of this market how much more profit they would make.

Guess what? Its not a far fetched dream. They will probably be there in 5-10 years.

 

I'm a big fan of EMN. Their preannouncement from a few weeks ago helped put investors on notice that there is a great earnings momentum story taking place. Throw in a reasonable valuation and 2.4% dividend yield and it's hard to resist.

 

All this talk of computer trading killing the chances for the individual investors is a bunch of rubbish. All this HFT/Algo does it create more volatility in the short run. Patient and opportunistic investors can take advantage of this by loading up the truck when they push shares too low. And trim profits when things run to high.

 

 

 

But as the market flirted with Dow 11,000 the “air got pretty thin up there”. Perhaps at that point enough investors pondered whether +1.7% growth is actually a good reading for this stage of the economic recovery. Or perhaps they also realized that jobless claims have been around 450,000 all year long. Making the new reading not so special.

 

So at the height of jubilation someone took out a pin and popped the intra-day bubble. From there we quickly retreated into the red and stayed there.

 

This reminds me of this clip from yesterday’s commentary:

 

 

The morning rally just seemed insane and I bet a lot more folks got sucked in. And sure enough that is just when the rug got pulled out. And why I think it will be hard to surmount Dow 11,000 without some mightily convincing economic data that makes some hardcore double dippers turn a new leaf and agree that it won’t happen. I don’t think the data is convincing enough for that crowd just yet.

 

Friday we have some more economic news for investors to digest including Personal Income & Outlays, Consumer Sentiment, and ISM Manufacturing. Once again, I don’t think that the recent mediocre showings will be enough to keep this rally alive. We need clearer signs of improving economic growth. That may be right around the corner with Alcoa kicking off earnings season on October 7^th.

 

 

 

I am reminded once again that economics is a soft science. Meaning non-exact. So we have experts looking at the same information and saying that it will create polar opposite results.

Its kind of like the country is trying to defuse a bomb and some experts say cut the red wire and the others scream cut the blue.

Who is right and who gets blown up?

 

2010 is the George Costanza market. At one point he realized that everything he did was wrong. So if he did the exact opposite of his natural instinct, then he would always be right.

That seems to be the best way to profit this year. Or how else do explain the current heights of the market. And how we could rally in the early AM from +1.7% GDP growth and the same old, same old 450K new jobless claims???

 

I've been on board with MOO for a few years in my long term account. The basic theme is that more of the world is becoming developed. So with that they will want more food, more shelter and more water.

MOO covers food.

Shelter = natural resources of all stripes and a million ways to play that. RYE, IYM and JOYG being some my favorites.

And water = PHO.
 

Here is the only logical explanation. The Chicago Bears are winning and employees are more productive.

 

 

 

Why does the Fed want to go down this road? Because of the rising possibility of deflation. Note that if this was just about having a little recession the Fed would not act. They are deathly afraid of deflation and the possibility that we have a lost decade or two like Japan. So they will use all the weapons at their disposal to try and prevent this from happening.

 

How do they do QE2 with the Fed Funds rate basically at zero? The game plan would be for the Fed to buy tons of long dated Treasury bonds. This should lower Treasury rates and provide a little spark to the economy. That’s because lower rates makes borrowing cheaper. But also it makes all forms of holding cash very unattractive. So people seeking more return should be willing to take on more risk. That is preferably in the form of expanding current businesses or starting new ones to get a better rate of return on their money. That is stimulative to the economy.  

 

A side effect of QE2 is that the dollar will most likely also drop versus other currencies making our exports more attractive in world markets. That sounds attractive on the surface. Yet in the long run a stronger currency is almost always preferred as it’s a sign of a healthy economy and responsible government (I can hear some chuckling by some on that last part).

 

So how is this good news for the stock market making it rise on Friday? If rates on Treasuries go lower, then it makes stocks all that more attractive by comparison. Especially with the impressive dividends being paid by your average S&P company these days. If you remember, I pointed this out when the 10 year Treasury got down under 2.7% making the stock market at Dow 10,000 a downright steal. Gladly we guessed right on that one. So if rates go to like 2.3% you can see why stocks would even be that much more attractive. .   

 

Again, this is what the Fed “may do” if they think we are moving too close to a period of deflation. And if they take these actions there is no proof that it will work as intended. That is why I don’t think the market should continue to move much higher on this news. Maybe take a shot at Dow 11,000, but then investors should be in a wait and see mode for Q3 earnings and GDP.

 

My concern about this earnings season is that it may be of the “buy on rumor sell on news” variety. Meaning that we rally into earnings and sell off on the news. And that is a sell off even if the reports are good. Because after rallying 8-10%, just being good probably won’t be good enough to rally further. That is the way that January 2010 earnings season worked out.

 

Of course if earnings and GDP are WELL above expectations, then certainly stocks would continue their advance and investors should move closer to 100% long.

 

 

 

Very few people are expecting exceptional GDP growth. At best we will have a muddle through economy and with that muddle through style equity returns. Now consider that cash or Treasuries pay near nothing. So against this backdrop you can see the appeal of dividend paying stocks to generate a decent return.

 

GOOG is no longer a high growth stock. So those investors expecting 30%+ growth sold their shares. Now a new crop of folks are buying up GOOG realizing this is an attractive large cap growth stock that will probably grow earnings 15-20% per year. When you consider a reasonable valuation for shares given these more reasonable growth prospects plus cash on hand, then you could easily see shares $600 - 650.

 

I personally have stayed away from the banks and just placed my bets elsewhere. To me the banks and the Gov are acting like my 8 and 10 year daughters.

How's that? When we ask them to clean up their rooms, they scurry around as fast as possible and throw all their stuff in the closets. On the surface the room is clean. Then when you open up the closets you get buried.

That's why I stay away from the bank stocks.