Investors have long sought out the magic bullet when it comes to investing in the stock market, but sadly, there is not one. However, there are techniques that have been shown to bear fruit in the short term.
Since we are in the midst of a 3½-year-old bull market, it may still be possible to achieve portfolio gains by buying the stocks of those companies whose stock price had suffered big declines in the past but whose future prospects for profitability have improved markedly.
This drop in the stock price could have been the result of poor management, bad strategic decisions or simply a bad economy.
If the problems had been internal in nature, the company management must have necessarily initiated a “turnaround strategy” that addressed and corrected those problems. Such stocks are often referred to as turnaround stocks.
Nine stocks in the S&P 500 stock index have increased in value more than the 67 percent increase that Apple has experienced this year.
Listed among these nine are stocks in the home building industry such as PulteGroup and Lennar. These companies have retrenched from the spectacular collapse of the housing market.
Another such turnaround has been Nextel, which has rebounded from huge losses to post modest profit gains.
Turnaround stocks can be good values if their future profit picture looks good. One place to look for turnaround candidates is among those stocks that have low price-earning ratios, which represents the current stock price divided by its current earnings.
The median S&P 500 company trades at 15 times projected earnings for its current fiscal year. Turnaround candidates would have a lesser PE and 80 stocks of this group have PEs of less than 10.
Peter Lynch, the now retired fund manager for Fidelity, wrote a seminal book in 1989 about the keys to successful stock market investing entitled “One Up on Wall Street.”
In that book, he opined that investing in turnaround stocks is a good way to inject diversification into one’s investment portfolio, since the performance of turnaround stocks is likely to not correlate with broad moves in the overall market.
This can be a bonus in today’s market, since it is not unlikely that the heights that we have been seeing in the market’s indices will continue. (I have been wrong before!)
Larry Pitkowsky, manager of the $195 million GoodHaven Fund, likes Hewlett-Packard, which sells for four times earnings.
Pitowsky believes that most investors are too narrowly focused on the fact that HP’s sales in its personal computer business are slipping, when in fact that division only contributes 15 percent of the company’s pre-tax profit.
It turns out that after her brief foray into the political arena, Meg Whitman; the company’s CEO, has been busily cutting staff and eliminating underperforming assets.
Whitman is also investing in research and development, cloud computing and data analysis, and she expects long-term returns from such investments.
A stock that I like a lot is American International Group. Yes, I know that the collapse of this company in 2008 was a major ingredient in our near financial meltdown, and I also am aware that AIG received a $182 billion injection from the feds, but the facts are that, given the most recent announcement from the Treasury, an impending stock sale will reduce the federal government’s interest in the company to 20 percent.
The company has unloaded all of the operations that caused the problems (who can forget the infamous credit default swaps?)
AIG’s stock price has risen 40 percent this year, and I look for an upside of $50 a share within 18 months (the stock is now around $33 per share).
The idea for this column came from an excellent article on smartmoney.com by Jack Hough.
Got a financial planning question for Greg? You may email him at firstname.lastname@example.org Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience.