Avoid Turnaround Stocks

One of my repeated warnings to investors is to avoid turnaround stocks. Companies rarely turnaround smoothly.
Poor-performing companies do indeed turn around, but it’s much rarer than people think. Hewlett-Packard (HPQ), under Mark Hurd, is an excellent example of a good turnaround story.
The difficulty in spotting a true turnaround is that the problems that initially hurt the company are often too complex to solve by changing a few items, like the person at the top. Vikram Pandit was just named the new CEO of Citigroup (C) and I wish him all the success in the world. Unfortunately, I think an organization with $2 trillion in assets in the middle of a credit crisis won’t be easily managed. (Note to Vikran: Break it up).
I think investors are easily tempted by possible turnaround stories. They see a cheap stock price and think there’s a bargain. Investors also like to personify a company, but this too can be a mistake. A professional athlete can have an “off night.” A large-scale public company usually doesn’t have an “off quarter.” The problem isn’t just execution. It’s also a host of variables from environment, competition, legal problems and a fickle public.
One stock that looks very tempting right now is Home Depot (HD). The shares have been plunging and it’s currently going for about 11 times next year’s earnings. So is it a turnaround? Maybe. Bob Nardelli is gone. Year-over-year earnings have been falling (although still positive) for the past four quarters. In February, we’ll find out if it’s five.
If the company does show that it has pulled out of its tailspin, then I think the shares could be worth it. Still, I’m hesitant. All turnarounds should be assumed failures until proven innocent.

Posted by on December 20th, 2007 at 9:52 am


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.