For all investors, turnaround stocks present a quandary. On the one hand, they offer superb potential returns as the market's failure to price in their growth rate means that capital gains can be exceptional. However, they also present a rather risky outlook, since they can easily disappoint and deliver worsening, rather than improving, performance.
For long-term investors, though, recovery stocks are a very appealing opportunity. That's because, while things could get worse before they get better and volatility may be high, long term investors have the time and patience to allow their investments to come good. And, while this may take years rather than months, the total returns can make the worry well worth it.
One stock that is a notable recovery play is BHP Billiton Limited (ASX: BHP). It is currently experiencing a challenging period, with the prices of a range of commodities such as iron ore and oil hitting multi-year lows. As a result, BHP's sales, margins and profitability are all coming under severe pressure, with its bottom line due to fall by 35.5% per annum during the next two years even though its production has increased in recent years.
Clearly, the present situation has been disastrous for BHP's share price, with it falling by 33% in the last year. However, it also presents an opportunity for BHP to refresh its strategy and become a better business for the long haul. For example, it has taken the opportunity to become more focused through the spin-off of non-core assets via South32. This should create additional efficiencies and allow BHP to drive through cost savings in the short to medium term. As a result, BHP's long-term position relative to its peers may improve, with its strong balance sheet and cash flow better able to cope with a prolonged downturn. And, with BHP trading on a price to book (P/B) ratio of 1.77, it appears to offer upside potential, too.
Similarly, hearing device company, Cochlear Limited (ASX: COH), has had a challenging number of years, with its net profit declining by 1.5% per annum during the last five years. And, while its recent results caused a decline of around 7% in the company's share price, Cochlear is delivering improving profitability.
For example, net profit was 56% higher in the year to June 30 and, looking ahead, further growth of over 26% is forecast for the current year as Cochlear's expanded margins are set to continue. Furthermore, Cochlear has strong cash flow, with cash flow per share having risen at an annualised rate of 15% during the last decade. This should provide it with the scope to continue to invest in new products, which could be the key to excellent gains in the long run. Certainly, its price to earnings (P/E) ratio of 32 may be relatively high but, with such a bright future, Cochlear appears to be well worth buying at the present time.
