Turnaround Companies Of 2020

The year 2020 was anything but dull for equity investors. Many made money in 2020 and on an average the risk-taking appetite was on the rise in 2020. The stock prices were no doubt volatile and several stocks more than doubled in 2020. The year clearly belonged to the defensives and penny stocks and to a great extent 2020 was also a year for turnaround stocks. Shreya Chaware highlights the turnaround stories that helped create wealth for investors in 2020 while also sharing key elements to watch out for in identifying turnaround stocks 

The year 2020 saw as many as 340 stocks double in value and by any yardstick it can be called one of the better years for equity investors. While the pharmaceutical and IT stocks grabbed headlines in the first half of the year it was the lot of the cyclical stocks that grabbed investors’ attention in the last part of the calendar year. Penny stocks managed to stage eye-catching performance even as IPOs filled the investors’ wallets consistently in 2020. While it looked like wealth is getting created from every investing opportunity, some of the most thrilling investing experiences were seen in turnaround stocks. Every year one can see some or the other company turning around itself and emerging victorious, thus creating huge amount of wealth for those showing conviction in the recovery of business. 

Defining a Turnaround Stock

Turnaround stocks are those stocks or companies that have witnessed consistent poor financial performance and at times one cannot guarantee if the company will survive. The poor financial performance could be triggered by any of following reasons – economic slowdown, high debts (Suzlon India), corporate governance issues (DHFL, CG Power), ultracompetitive sectoral environment (Idea Vodafone), poor business practices, wrong strategy adopted by the company, government policy changes and decisions, international embargo, etc. 

After reflecting poor financial performance, the turnaround stocks are those that attempt to fix the problem and make a comeback, which is reflected in the improving financial performance usually seen in the quarterly results.

For example, three to five consistent quarters of poor financial performance followed by improvement in the quarterly performance. In simple words, it is when a company becomes profit-making from a loss-making one – therefore called a turnaround stock.

Turnaround Stories of 2020

With more than 340 multibaggers in 2020 it was very easy to miss out on every opportunity that markets had to offer in 2020. Turnaround stocks or ideas are even more difficult to identify as it takes lot of patience, acumen and timing skills. The years saw several companies stage a comeback and indeed the stock prices suggest huge wealth creation for several investors who showed conviction in the beaten down stocks. The table below highlights the turnaround stocks that have shown some kind of recovery not only in earnings but also in the stock prices.

✓Turnarounds are perhaps best described as the ultimate contrarian play, since they are bet on a company most others don’t believe in.

✓ Turnaround investing is all about cash flows!

✓ Having an exit strategy on turnaround stocks is very difficult.

Identifying Turnaround Opportunities To identify turnaround investment opportunities one has to closely track the financial performance and keep tab of any substantial changes that can impact the very survival of the company and can facilitate the recovery going ahead. It is not very easy to identify the turnaround stocks; however, the following pointers can be used as guidelines:
1. Change in Management: There are numerous examples of how a change in management has led to a turnaround in a company. Yes Bank, IndusInd Bank, Tata Motors, CG Power are just some of the examples of turnaround stories due to change in management.
2. Change in Strategy: It is possible that a company emerges profitable from being a loss-making one due to appropriate change in the business strategy. Investors have to keep a track of the change in the strategies and analyse if the strategy can help the company in distress become profitable.
3. New Product Launches: New product launches can be extremely important for companies that are going through a rough patch. One should keep a close track of new product launches and asses if such launches can help the company become profitable.
4. Government Initiative or Policy: It is rare but possible that a company may become profitable owing to the government policy decision or an initiative to promote and protect a particular industry. Investors have to closely monitor if any government decision is going to help the beleaguered company under study.

Highlighting Turnaround Stocks

The table below highlights those stocks that have turned profitable in the latest quarter after posting losses for several quarters. We can see that most of the loss-to-profit companies are able to beat the markets on YTD and three months’ timeframe but not all such stocks are able to outperform the markets. Hence, each turnaround story must be analysed separately before making an investment decision. Mere lossmaking to profit-making does not ensure market-beating returns but is a good starting point to identify a turnaround stock.

Conclusion

While there is no doubt that turnaround stocks have the highest potential for returns, betting on them is not everybody’s cup of tea. It requires above average patience and insight into a company before betting on a beaten down stock. Also, beaten down stocks that become penny stocks are susceptible to stock price manipulation and hence it is very easy for novice investors to lose money on such bets. It is very important that investors study the exact nature of the business problem and ensure that there is a solution in sight to the business problem. If the timing is accurate, bagging a 10-bagger by investing in a turnaround stock is not a far-fetched idea.

It takes tremendous amount of courage and ability to hold on for long term once the bet has been made in a turnaround story. Conviction is must and hard-core research is required to take sizeable position in a beaten down stock that is expected to stage a comeback. Investors have to keep a close track of the free cash flow situation of the company. Exceedingly high debt level is a problem and investors have to monitor the debt situation regularly. Amount of cash in hand versus the longterm debt situation needs to be analysed carefully. A troubled company with minimal or nominal debt has a better chance to rebound successfully.

"I think you have to learn that there's is a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies."
- Peter Lynch

Close attention to the management commentary is of utmost importance. One has to assess how bullish and confident is the management on the turnaround possibility. Tata Motors, for example, turned around from a loss-making company with the management making bold statements such as being debt-free in a pre-defined time horizon. Such confidence from the management about bright prospects ahead can be reassuring for investors. Similarly, in case of turnaround of CG Power, the new management which took over the company i.e. Tube Investments Limited paid off a majority of the existing debts and made statements suggesting that the company would be totally debt-free in five years’ time. Such confidence-boosting statements need to be discounted carefully by investors.

Also, it helps to know if the new management that is tackling the business problem has some previous experience in turning around companies. For example, business leader Laxmi Mittal is known worldwide for his ability to turn around a loss-making company into a profit-making one. Betting on management change can also fetch great dividends. One of the trickiest aspects of betting on a turnaround stock is deciding on the exit strategy. As it stands, the exit strategy for normal stock investing in itself is a tricky business so that when it comes to betting on turnaround stocks it become even more difficult.

Deciding on an exit strategy in a turnaround story is always difficult for average investors because there are too many factors at play that influence the turnaround success. It becomes almost impossible for average investors to take a call on how elongated the turnaround cycle could be due to motley of factors that keep the situation fluid and beyond comprehension of average investors. Hence, betting on beaten stocks with a hope of turnaround is not for average investors. Betting on turnaround stocks is an ultimate contrarian play as one has to bet on a company most others don’t believe in.