The Benefits of Turnaround Firms

If you are looking for places to invest as the current bull market ages, try turnaround stocks, says The Wall Street Journal’s Jack Hough.

Hough says that several turnaround firms — those that have had big problems and are now trading on the cheap — have had big years in 2012. Among them are several homebuilders, as well as Gap and Sprint Nextel. Hough says that turnarounds are attractive not only because they can produce big returns if they get their act together, but also because they provide diversification. “As famed Fidelity stock-picker Peter Lynch explained in his 1989 book ‘One Up on Wall Street,’ ups and downs for turnaround stocks are less tied to broad market movements,” Hough writes. “That is a perk for investors who expect the 3 1/2-year stock rally to slow or stall.”

Among those top stock-pickers who’ve been betting on turnarounds lately is Oakmark’s Bill Nygren, whose fund bought shares of much-maligned American International Group earlier this year, notes Hough. Hough offers some tips for how to find good turnaround candidates, as well as some broader advice: “Investors who buy turnaround stocks shouldn’t fall in love with them,” he says. “If the valuation rebounds to average market levels, or if signs mount that efforts to improve aren’t working, it is time to sell. Also, fund investors should expect a bumpy ride from turnaround-heavy portfolios. … That sort of turbulence will keep most investors away. But to ones who like shopping for turnarounds, that is the whole point.”