While it makes a lot of sense to buy shares in companies that are performing well and which have a history of excellent financial performance, turnaround stocks can be excellent places to invest. That’s because, while inherently riskier than their better performing peers, they can offer superior share price growth potential over the medium to long term.
For example, the likes of Quindell (LSE: QPP) and Tesco (LSE: TSCO) (NASDAQOTH: TSCDY) have had a troublesome period over the last year. In the former’s case, it has seen its senior management team depart after miscommunication regarding share sales, has sold off its major division and undergone a significant independent accounting inquiry that has said its revenue recognition practices, while aggressive, were acceptable.
Meanwhile, Tesco has also changed its management team and is in the process of selling off its Asian operations as it seeks to become leaner, more efficient and more profitable in future. In addition, it has shifted its strategy towards improved customer service, which seems to make a lot of sense. After all, the UK supermarket sector is simply not growing as quickly as it was a handful of years ago and, as such, operators such as Tesco must do more to win customers and improve their loyalty.
Looking Ahead
However, while Tesco has a clear strategy to try and win back customers and improve its financial performance, Quindell appears to be in the midst of working out what kind of business it will be in future. Certainly, it has numerous options and opportunities available to it, but unlike Tesco, it has not yet communicated this to its investors. For example, while it is set to focus upon telematics and insurance technology, a clear plan to grow the business and a decision on who will lead it has not yet been taken.
This contrasts sharply with Tesco. Its CEO, Dave Lewis, sat down with investors soon after he commenced work at the company and laid down his vision for the business. This was a very sensible step to take and, while he was brutally honest about how challenging the future would be for the company, investor sentiment picked up sharply following the announcement and has helped to push Tesco’s share price northwards by 29% in the last six months.
Valuation
Of course, Quindell’s current share price appears to place little (if any) value on its non-professional services divisions. And, while they may take time to generate improved financial performance, they are likely to have at least some value moving forward. However, until we know how they will be managed, it seems prudent to wait before buying a slice of Quindell.
That’s especially the case since there are a number of other, more appealing turnaround stocks available right now. Tesco, of course, falls into this category, with the company offering strong earnings growth potential at a very reasonable price. In fact, Tesco trades on a price to earnings growth (PEG) ratio of just 0.6, which indicates that it has a sufficient margin of safety so as to make the risks seem worth it for the potential reward.
