Buying turnaround stocks is inevitably risky, but can prove to be highly rewarding. Their financial performance can prove to be somewhat disappointing in the short run, since their track records often include lossmaking periods. However, the market has historically responded rather positively to gradual improvements in a company’s bottom line. As such, now could be the right time to buy turnaround shares Balfour Beatty (LSE: BBY) and Barclays (LSE: BARC).
A long way to go
In Balfour Beatty’s case, its financial improvement still has a very long way to go. Thursday’s results show that in 2016 it was able to return to profit after two years of losses. This should provide its investors with some encouragement – especially since its order book increased by 15%. Furthermore, underlying revenue was 4% higher, while its strategy of reducing costs continues to gather pace. In fact, over the course of its two-year plan, it has removed £123m in costs from the business.
As part of Balfour Beatty’s turnaround plan, it has sought to improve governance and reduce risk. This appears to be a sensible step to take and should lead to fewer mistakes in major contracts. In turn, this could lead to improved investor confidence and a higher valuation over the medium term.
The company’s outlook remains positive, with its bottom line forecast to rise by 134% this year. This is due to be followed by further growth of 43% in 2018, which indicates that there is still a long way to go in Balfour Beatty’s turnaround plan. Its shares trade on a price-to-earnings growth (PEG) ratio of just 0.3, which suggests that now could be the perfect time to buy them.
A changing business
While Balfour Beatty may be near the start of its turnaround plan, Barclays is making relatively minor adjustments to its business model. It has kept dividends at a relatively low level in order to boost its financial strength. This should help the bank to ride out any potential issues regarding Brexit. It is also seeking to restructure its business in order to reduce its risk profile, which could lead to a higher valuation.
With Barclays trading on a PEG ratio of 0.5, it seems to offer a highly enticing risk/reward ratio. However, the major catalyst for its shares over the medium term could be dividend growth. Its dividends are forecast to rise from 3p per share in 2017 to 7.7p per share in 2018. This puts Barclays on a yield of 3.3% from a dividend which is set to be covered 3.1 times by profit.
As such, it could become a more attractive income stock, while its low valuation and turnaround potential could allow it to beat the FTSE 100 in 2017 and beyond. While economic challenges for the UK and global economy cannot be ruled out, the margin of safety included in the bank’s valuation suggests that it could still offer investment gains in the long run – even if the macroeconomic conditions are somewhat challenging.
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Peter Stephens owns shares of Barclays. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.