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Three beaten-down stocks, ready for a turnaround Add to ...

John Reese is founder and CEO of Validea.com and its Canadian site Validea.ca, as well as Validea Capital Management, and is a portfolio manager for the Omega American & International Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it. Globe readers can get a 25-per-cent discount for a limited time.

It’s only February and temperatures remain chilly, but one of the first signs of spring has arrived: spring training. It’s a time of optimism, as the 29 teams that failed to win the World Series last year start with a clean slate and a chance to improve on the previous season’s shortcomings.

One of the teams that looks ready to improve the most this season is the Toronto Blue Jays.

If the Jays were a stock, they would have been hit hard in 2012, as a team initially considered a dark horse playoff contender limped to an 89-loss season.

But in just a couple months, Jays’ “shares” have surged thanks to off-season trades that have landed the team All-Star shortstop José Reyes and reigning National League Cy Young Award winner R.A. Dickey, among others.

Whether the Blue Jays do in fact have a big bounce-back season remains to be seen. But with real stocks, such turnarounds happen quite a bit.

Humans are an emotional bunch, and investors will often overreact to the downside when a company goes through a rough patch. Then, when investors realize that the reality wasn’t as bad as their fears, the beaten-down stock jumps.

Gurus such as hedge fund manager Joel Greenblatt or Canadian-born fund manager David Dreman have made a living by finding ways to identify beaten-down stocks that are poised for turnarounds.

Even mutual fund great Peter Lynch, who is known primarily as a growth investor, sometimes delved into turnaround plays.

The most successful players in this game focus on the numbers – a stock’s fundamentals and a company’s financials – rather than hunches or guesswork.

With that in mind, I recently used my Guru Strategies (quantitative models based on the approaches of Mr. Lynch, Mr. Dreman, Mr. Greenblatt and other investing greats) to find some good bounce-back stock candidates in the Canadian and U.S. markets right now.

Note that some of these are smaller firms or economically sensitive businesses, and they all have issues (otherwise, there wouldn’t be anything for them to bounce back from). That can make them susceptible to short-term volatility – and not for the faint of heart.

As always, you should invest in picks like these within the context of a well diversified portfolio.


CML HealthCare

Mississauga-based CML operates more than 200 lab and diagnostic imaging sites across Canada, processing more than 40 million tests a year. It missed on its third-quarter results, and cut its expected dividend payouts for 2013, causing shares to tumble sharply last fall. In the past 12 months, they’re down more than 30 per cent.

However, the model I base on the writings of Mr. Greenblatt thinks it’s been hit too hard and is a good bounce-back candidate. His approach is a remarkably simple one that looks at just two variables: earnings yield and return on capital (ROC). My Greenblatt-inspired model likes CML’s 10.8-per-cent earnings yield and 128.2-per-cent ROC, which combine to make the shares the 23rd-most-attractive in my Validea Canada database of stocks. (The database looks at approximately 1,000 publicly traded Canadian equities and ranks them based on the combined earnings yield and return on capital metrics.)


Joy Global

Joy Global provides mining equipment and services for both the underground and above-ground mining industries.

Shares have fallen nearly 25 per cent over the past 12 months, with much of the decline occurring before August of last year, as fears about China’s slowing growth and the United States’ own fiscal problems hurt this economically sensitive stock.

Since August, Wisconsin-based Joy has made up about half the ground it had lost, and two of my models think it’s ready to continue the turnaround. My Lynch-based approach likes the firm’s combination of strong long-term growth (20.4 per cent, using an average of the three-, four- and five-year earnings-per-share growth rates) and a low price/earnings ratio (8.9). Mr. Lynch famously used the P/E-to-growth (PEG) ratio to find bargain-priced stocks, and when we divide Joy’s P/E by its growth rate, we get a PEG of 0.44. That falls into this model’s best-case category (below 0.5).


TransGlobe Energy

This Calgary-based oil and gas explorer, whose efforts are focused in Egypt and Yemen, was hit hard at a couple different points in 2012, first because of the Arab Spring uprisings and then because of poor third-quarter earnings. The company’s stock is down 23 per cent over the past 12 months, and more than 40 per cent from its 2012 high.

But as with Joy Global and CML, my models think the hits TransGlobe took were too severe. My Lynch-based model likes the firm’s 33.3-per-cent long-term growth rate and 7.3 P/E ratio, which make for a stellar 0.22 PEG ratio. It also likes that TransGlobe’s debt/equity ratio is a reasonable 40 per cent. (The company has a market capitalization of $600-million.)

My Greenblatt-based model, meanwhile, likes TransGlobe’s 23.6-per-cent earnings yield and its 30.8-per-cent return on capital. The stock ranks as the 14th best in the overall Validea Canada database.

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