One of the most profitable types of investment can be buying shares in a turnaround play. Of course, it can be one of the riskiest types of investment, too, with there being the potential for further declines in both the company’s performance and also in its share price. As such, it can be crucial to find potential turnaround stocks with significant margins of safety, thereby putting the risk/reward ratio much more in the investors’ favour.
Oil Declines
One sector that has the scope to become a top notch turnaround space is the oil sector. That’s because the price of oil has slumped to around $60 per barrel, having been over $100 per barrel less than a year ago. As such, the profitability of the sector has been hit incredibly hard and this has caused the valuations of a number of oil stocks to decline considerably and make them hugely tempting.
Of course, the oil price could once again move lower, but looking at the valuation of oil major, BP (LSE: BP) (NYSE: BP.US), this seems to be adequately priced in. For example, while it has a price to earnings (P/E) ratio of 18.6 (which is considerably higher than the FTSE 100’s P/E ratio of 16), BP is expected to increase its bottom line by 83% in the current year, followed by growth of 31% next year. This puts it on a price to earnings growth (PEG) ratio of just 0.5, which indicates that it offers superb value for money.
In addition, BP’s other challenges (besides the oil price) also appear to be adequately taken into account via its current valuation. For example, the fallout from the Deepwater Horizon oil spill and challenges in Russia may cause profitability to grow at a slower pace than it otherwise would do, and also cause investor sentiment to be slightly weaker, but with such an appealing valuation, BP seems to be a strong buy.
Clearly, sector peer, LGO Energy (LSE: LGO), offers far less diversity and stability than BP, but its progress has been significant. For example, it has recently been able to raise capital via an oil swap facility with BNP Paribas and, as its end of April update showed, it has completed the drilling of its first well in 2015 in record time, with progress being very solid. Furthermore, LGO has explicitly stated that even with the oil price at such low levels, its Goudron field remains economically viable, which bodes well if the price of oil does disappoint moving forward. Despite this, its share price has slumped by 16% this year, which makes it a relatively appealing turnaround play.
Banking
Clearly, the UK banking sector has endured a tough time in recent years and, just as with the oil sector, there are numerous turnaround stories on offer. One of the most appealing is RBS (LSE: RBS) (NYSE: RBS.US). That’s because it is expected to increase profitability at a rapid rate this year, with it forecast to stand at 29p per share versus less than 1p per share last year. This provides RBS with tremendous scope to increase dividends, with even a 50% payout ratio based on the current year’s forecasts equating to a dividend yield of 4.1%, for example.
And, while it may take time for dividends to reach that level, as the bank remains in recovery mode, the prospect of it occurring over the medium term could boost investor sentiment in RBS and push its share price higher.