His material can be found on the Internet at www.bankruptcydata.com and www.turnarounds.com. He is also a Trustee of the Putnam Group of Mutual Funds.
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Be willing to go against the crowd .
By their nature, turnaround stocks are unpopular. That's why they have so much profit potential. If you wait until they are popular again, you will miss most of the gains. For example, back in 1993 when IBM dropped down to about 10 (adjusted for splits ) most analysts called it a dinosaur. Then, when the stock got back up to 100 a few years later, everyone loved it again.
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Previous stock prices are irrelevant.
Too often investors fall into the trap of saying "This stock used to trade at 50, and now it is at 5 - it must be a bargain." A stock is only a bargain if it is currently undervalued, and that depends solely on what the stock is actually worth today - not what investors thought it was worth last month or last year.
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You can lose just as much money in a $1 stock as in a $50 stock.
This is a corollary to Rule #2. Many investors also say "The stock has dropped to $1 per share; how much lower can it go?" The answer, of course, is "to zero." Stocks do become worthless. And if the stock goes to zero, you will have lost just as much, on a percentage basis, if you bought it at 1 as you would have if you'd bought it at 50: 100% of your money.
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Look for a solid core business.
A company can only rebuild if it has a solid foundation on which to base its recovery. If the business was based on a fad or an obsolete technology, the stock is not likely to rebound. But if the company's basic business remains sound, there is a better chance the stock will bounce back.
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Evaluate management's ability to turn things around.
Evaluating management is important for any stock, but it is particularly important in a turnaround situation. In many cases, the management that got the company into trouble isn't likely to be able to get it out of trouble again. Therefore, a change in top management can be a good sign.
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Look for someone else to do the heavy lifting .
The presence of a big investor who is willing to get involved and shake up the company can be a good thing. But make sure that the big investor owns the same security that you do. Sometimes the big investors own bonds or preferred stock, in which case they may not care what happens to the holders of the common stock.
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Check the debt.
A heavy debt burden is often part of the reason that the company is in trouble in the first place. And a high level of debt significantly reduces the company's flexibility in making necessary changes to its business. Finally, if the company must restructure, the debt has to be taken care of before stockholders get any value.
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Avoid stocks of companies in Chapter 11.
This is related to Rule #7. If a company goes into Chapter 11, the basic rule of bankruptcy is that senior creditors must get paid off before junior creditors get anything. Stockholders have the most junior claims of all in a bankruptcy, and very rarely is there enough value in a bankrupt company for the stockholders to receive anything. This is also related to Rule #2 and Rule #3 because Chapter 11 stocks are often temptingly low in price, but they almost always end up being virtually worthless.
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Be patient.
Turnarounds take time. Moreover, even if the company has turned around, it may take still longer for investors to recognize the turnaround and to get comfortable with the stock again. (After all, many investors were burned by the stock on the way down.)
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Diversify.
Diversification is important in any type of investing, but it is particularly important in turnaround investing. Turnaround situations always are affected by a large number of variables , and no matter how much research you do, you will always have some situations that don't work out the way you expect them to. The best way to minimize your risk in turnarounds is to spread your money over a large number of different stocks. That increases your chances of having some big winners to offset your inevitable losers.
