Buying turnaround stocks can be a risky business. By their very nature, they are underperforming in one sense or another. They may have internal challenges, difficulties in one division, or face an uncertain trading environment. As such, the potential to lose money from investing in them is arguably higher than for many other companies. Likewise though, the potential rewards may also be above average. With that in mind, here is one turnaround stock I’m avoiding, and one I’d buy right now.
High valuation
Reporting on Friday was online electrical retailer AO World (LSE: AO). The company is on track to deliver its long-term strategic plan according to the update, with results for the full year due to be in line with market expectations. Encouragingly, customer satisfaction scores remain high, while the rollout of further categories such as computing continues across the UK and Europe.
Despite high customer satisfaction and being in line with its strategy, the company faces an uncertain trading environment. The major domestic appliances (MDA) market in the UK is seeing lower volumes versus the prior year. This situation could worsen, since inflation is now higher than wage growth. The result could be reduced demand for a range of consumer goods, which could cause AO World’s financial forecasts to come under pressure.
With the company being lossmaking at the present time, its turnaround to profitability is due to take place next year. While this in itself may improve investor sentiment to some degree, it appears as though the market has already factored-in the company’s improved financial outlook. For example, AO World trades on a forward price-to-earnings (P/E) ratio of 203. This suggests there is a lack of a margin of safety and that it may be a stock to avoid.
Improving outlook
While AO World may not be worth buying right now, fellow turnaround stock Findel (LSE: FDL) could have significant investment appeal. It has experienced difficulties for a while, with it being lossmaking in each of the last two financial years. However, after a restructuring and asset disposal programme, the business appears to be in better shape and has a much brighter future.
In fact, Findel is due to return to profitability this year and follow this up with earnings growth of 19% next year. This has the potential to boost the company’s share price through improved investor sentiment following a 4% decline in the last month. And with the company’s shares trading on a price-to-earnings growth (PEG) ratio of just 0.4, there appears to be a wide margin of safety on offer.
Certainly, the risk of investing in Findel may be relatively high. The the company still has some way to go before it is turned around. Downgrades to its earnings forecasts cannot be ruled out. However, with a low valuation and a strategy which seems to be working well, it could be a worthwhile buy at the present time.