Spotting a Turnaround

When you’re a value investor, you often look at stocks that are far off their highs. The problem is that a stock that’s down only means it’s down from where it was, and not necessarily where it ought to be.

The thing with business is that turnarounds are very, very hard. Yes, they happen, but it ain’t easy. Business isn’t like sports where a team that’s leading will play very conservatively, and a trailing team has a shot of getting back in it. In business, success often breeds success (though it can breed complacency as well). Imagine a basketball game where the team that makes a basket gets to take the ball out again. That’s the business world.

J.C. Penney ($JCP) has gotten crushed lately and the company is in a world of hurt. So does that means it’s a value? Possibly, but I’m staying away. Target ($TGT), on the other hand, is down as well, but I like Target a lot more (though I’m not willing to call it a buy just yet).

Here’s the important lesson: There are some key differences between a stock that’s down (like JCP), and a stock that’s down and could be a good buy (like TGT). For me, the first sign is looking at the dividend. JCP doesn’t pay one but TGT does. That’s a major distinction. The second is cash flow. JCP is hemorrhaging money. They’ve been losing money, are losing money and will most likely continue to lose money for some time.

Target, meanwhile, is in rough shape but it’s making money — more dollars are coming in than are going out. Their earnings this fiscal year will be down from a year ago. What happens next year, however, is a question mark. If the company resumes its growth rate, it’s very likely that Target is a very good buy here.

So remember that just because a stock is down doesn’t mean it’s a good buy. You need to look for key anchors like cash flow and dividends to tell you if the decline is (probably) transitory.

Posted by on January 16th, 2014 at 2:25 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.