December 11, 2012

The Turnaround Stocks: Best Performers of the Year

Written By Chloe Lutts Jensen

Chloe Lutts Jensen

One of the longest-running Investment Digest features is our annual Top Picks issue, for which we ask all our contributors to send us their single favorite stock to buy for the coming year. In July, we ask them to update us on their picks. And finally, in December, I like to check on how all the picks did, and see whose picks became the best performers. Sometimes, interesting themes emerge, although more often, each pick has succeeded for its own individual reasons.

This year’s winners all have interesting stories.

The best performer (by far) is office superstore chain OfficeMax (OMX), which has more than doubled in price year-to-date. OMX was picked by George Putnam III, editor of The Turnaround Letter. As you can tell from its name, his newsletter focuses on turnaround situations, and he clearly has skill at selecting promising rebound candidates from a field of beaten-down stocks, many of which may never recover.

As you can see in the five-year chart below, OMX crashed hard following the 2008 financial crisis, and then its rebound failed in mid-2010. When Putnam recommended OMX at the beginning of this year, it was trading in the mid-4 range, its lowest level since early 2009.

But Putnam saw great value in the stock at that level, as he explained in his recommendation. Here’s some of what he wrote at the beginning of the year:

“One of our favorite stocks for 2012 is OfficeMax, a leading seller of office products in both the business-to-business and retail channels. The stock declined steadily through much of 2011 as investors fretted about the possibility of a new recession in the U.S. While OfficeMax is sensitive to economic activity, we believe that investors have significantly overreacted in dumping the stock. It now looks as though the economy isn’t doing so badly after all. Moreover, even if there is some weakness in business spending, OfficeMax is now much more efficient than it was in past downturns. The company is focusing on several areas for new growth, including overseas expansion, increased online presence and new ‘integrated solutions’ for offices. By most measures, the stock looks very cheap, with a price-to-earnings ratio of less than nine and a price-to-sales ratio of 0.05 (both based on trailing 12-month numbers). Even without renewed growth, a slight change in investor perceptions about OfficeMax could send the stock up sharply.”—George Putnam, III, The Turnaround Letter

Six months later, OMX was up slightly, but still depressed. Putnam stuck by his turnaround thesis though, writing, “Our 2012 pick, OfficeMax, has held its own for the first half of 2012 (up about 11%), but its turnaround is still very much a work in progress. Despite continued sluggishness in the economy, the company posted improved results for the first quarter. Management is being conservative and predicting flat sales and earnings for the balance of the year, but we think the company will do a little better than that. The stock is still very cheap, with a P/E ratio of only about seven times expected 2012 earnings. If the economy picks up at all, especially in the small business sector, the stock should perform very well. OfficeMax remains one of our top picks for the balance of the year.”

Shortly after that update, OMX reinstated its dividend, announcing a two-cent dividend payable August 31. And the rest, as they say, is history: OMX has more than doubled in price since July, climbing strongly but neatly from just over 4 to just under 10.

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This year’s second-best-performing Top Pick was also a turnaround story, of a sort. Lennar Corp. (LEN) was chosen as a Top Pick by Cabot Market Letter Editor Michael Cintolo, who normally focuses on fresh-faced growth stocks with promising new products or stories. But as he wrote in this year’s Top Picks issue:

“Throughout market history, three-quarters of all big winners have been growth stocks, those with big sales and earnings, huge profit margins and a unique and potentially revolutionary new product and service. But the other quarter of big winners have been turnaround stories, as earnings rocket higher following a tough year or two or three. Today, I think homebuilding (and other housing-related) stocks are in the midst of a big turnaround, and Lennar could ride that wave to big gains in 2012.”

Cintolo then pointed to Lennar’s last five quarters of positive earnings, drastically reduced costs and improving analyst estimates. Plus, he noted, housing market statistics like new housing starts were already improving, albeit from rock-bottom levels. He concluded:

“No one (including me) is calling for a new housing boom, but if activity simply moves up to average levels, it would imply a near-doubling in demand! With all the weak hands out and major signs of accumulation since the stock’s October low, I think Lennar should do very well in the year ahead.”—Michael Cintolo, Cabot Market Letter, January 2012

His hypothesis has now been proven right; Lennar has gained 65% since the January recommendation.

As I noted earlier, sometimes the best performing Top Picks suggest an interesting trend of the past year. And sure enough, Lennar and the next three best-performers do all have something in common: They were the four best-performing Top Picks at mid-year.

Number one was LEN, which was already up about 40% at mid-year.

Number two at mid-year was petroleum refiner Holly Frontier Corp. (HFC), recommended by The Stock Prospector Editor Eric Dany. In the second half, HFC nearly doubled its mid-year gain of about 30% and buyers now boast a gain of almost 60%. That puts HFC in third place in our rankings.

Number four, with a 50% gain, is an RBS preferred share (the Q-series) recommended by Global Investing Editor Vivian Lewis. Its unsurprising mid-year ranking: number three.

Finally, the fifth-place runner-up at year end, which was also in fifth place at mid-year, is Franco Nevada Corp. (FNV), with a 41% gain since the original recommendation. FNV was recommended by Adrian Day’s Global Analyst Editor Adrian Day.

So, aside from OfficeMax vaulting into the top slot, the standings at year-end look a lot like the standings at mid-year. (The fourth-best performer at mid-year, Tesla (TSLA), was kicked out of the top five by OMX but is still number six.) Partially that’s a function of the overall market’s action this year: October and November’s significant losses, although now more than made up for, made it difficult for new winners to emerge. But with the exception of OMX, the Top Picks that did best managed to make significant gains in both the first and second halves of the year.

It’s a little messy, but in the Google finance chart below you can see the year-to-date performance of Lennar, Holly Frontier, RBS-Q and Franco Nevada, compared to the three major indexes (S&P, Dow and Nasdaq).

The major indexes are the tame-looking red, yellow and blue lines trundling along the bottom of the chart. Our winners, as you can see, pulled ahead early and never looked back.

To my mind, there are two lessons here.

First is the general: don’t be afraid to buy into strength. Some investors would look at LEN and HFC, up 40% or 30% at mid-year, and assume they’d missed the boat. But really strong stocks can and do rise further and longer than anyone thinks they’re capable of. It’s an extreme example, but if you’d bought Apple at the end of 2004, after it had gained 200% in 12 months, you would be sitting on a 3,000% gain today. Not bad considering you “missed out” on the original 200% increase.

The second lesson is specific to Investment Digest subscribers, or anyone thinking about becoming a subscriber: Buy the winners at mid-year! If you’d taken $5,000 and bought the five best-performing Top Picks in the July update issue, you would have $6,012.90 today. Obviously, you would have done even better by buying those five, and OfficeMax, at the beginning of the year (you’d have $8,236.60), but we can’t all be as clever as George Putnam, Mike Cintolo, Eric Dany, Vivian Lewis and Adrian Day. (Although a subscription to the Investment Digest certainly helps. Nudge, nudge.)

Wishing you success in your investing and beyond,

Chloe Lutts
Editor of Investment of the Week

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4 Responses to “The Turnaround Stocks: Best Performers of the Year”

  1. little rat says:

    keep me on ur mailing list—look at arr paus monthly dib abt 15%

  2. Chloe Lutts says:

    I’m glad you’re enjoying Investment of the Week Emails.

  3. Don Hoffman says:

    A good analysis would be a review of the past three years annual best picks by recommender to see highs and lows by year to see who is on top for a slightly longer period than past six months. Would give me more confidence in picking ability and also show size of company.

  4. Chloe Lutts Jensen says:

    Hi Don,

    Thanks for the suggestion. We’re working on compiling more data every year so we can offer those kinds of analyses. Maybe check back at the end of 2013!

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