Turnaround investment strategy
Investing is all about the unknown future. More unpredictable the future, the better maybe the investment returns. Often an investment strategy of investing in high-quality companies is promoted by media and/or fund managers. There is a lot of merit in investing in high-quality, cash-generating businesses. The problem is the price. These businesses are quoted at very high valuations.
Price is what you pay, and value is what you get
Justifying any price for a quality business is not the right approach. You wait for bad news, a bad quarter, margin pressure, etc. In the short term, markets often react and may provide an entry price. Note that the right time will be filled with pessimism and uncertainty. If you have a good understanding of the business, you will be able to make a contrarian decision. There are only 50-60 high-quality businesses in India that are often high-priced. What other option can you evaluate where the price you pay is substantially less than the value you get? One such strategy is to identify turnaround businesses. These are businesses that have gone through a certain turmoil in the recent past. A piece of negative news often beats down the share price. The idea is to find businesses that are equipped to handle the crisis to become profitable again. Some of the areas where you can find these businesses: Recently changed management Top management is key in turning around businesses. If there is management restructuring, especially CEO/MD, be on the lookout. Follow the company to understand the changes the company is doing. This analysis is often done over 2-3 quarters. You are trying to assess whether the changes generate any improvement. Margin expansion cost control, and revenue focus is often the strategies that the top leader would focus on and turn around. Business Strategy The company may reflect on a broad business structure and get rid of loss-incurring projects or businesses. It may be looking at the product level strategy, cost reduction options, etc so that margins improve. Quarterly earning calls can be a key input for this assessment. Managing cash flows One of the key aims of business strategies is to improve cash flows – the net of operating expenses and revenues – by cutting costs and/or selling businesses not important to the core business. So, on one side, there may be signs of cost reduction and on the other side, revenue improvements. It takes a few quarters before you see the company becoming profitable. Approach The company’s worth is future cash flow discounted to the present. When the market is not able to see cash flows, the share price may often be under stress. It is a good strategy to allocate 0.5-1% and gradually build or exit the position. It takes a while, a few quarterly reviews, listening to management, talking to customers/suppliers, etc. before you can build a high conviction in the business.