Five Companies Poised for Better Days

I'm told that having a shiny 1968 Ford Mustang makes you pretty cool. But I think buying a slightly scuffed 1968 Ford Mustang at a junkyard for a song--and then restoring it to its formal glory--is 10 times cooler.

So it often is with investing. Many dream of finding that rare gem of a company, perhaps once great and admired but now exiled to the proverbial junkyard of the market, just waiting for the right buyer to come along to recognize its proper value. There is something especially satisfying about spotting a company that's fallen on hard times but is primed for a turnaround. Of course, the potential monetary rewards can be savory, but there is also a gratifying psychological kick to be had in besting Mr. Market and the hordes of investors who dumped the company in troubled times.

But turnarounds can be tricky. Just because a company's fortunes have waned and the stock has fallen doesn't mean it's any cheaper. Perhaps the industry is being pressured by new competition, or technological progress is making the company obsolete. Maybe the company is levered to the gills and is liable to go bankrupt before it fixes itself. There are a thousand possible reasons why a turnaround might plummet to the ground instead, but we still feel that the theme is a pretty good hunting ground for astute investors.

To help you in this task, we've constructed a simple screen to ferret out potentially great companies poised to return to their former glory. The screen uses the following criteria:

1. A Morningstar Rating of 4 stars or better
2. A moat rating of at least narrow
3. Declining operating income in the most recent year
4. Operating income growth of at least 10% per year, and return on equity of at least 15% per year, for three years previous to the most recent year

In betting on turnarounds, we think it's smart to choose a company with a solid moat. In general, a business with sustainable competitive advantages should stand a much better chance of fixing itself than a company without them. Further, if the company's industry is in a cyclical downturn, companies with moats should survive and exit the slowdown in much better shape than their weaker brethren. In fact, if the weaker companies go bankrupt, the survivors may become stronger than before.

Using our screen, we've highlighted several interesting prospects. As you can see, all of these stocks are well off their highs, and we believe their long-term business prospects are perfectly intact.

Zimmer Holdings
Moat Rating: Wide | Fair Value Uncertainty Rating: Low | Morningstar Rating: 5 Stars

From the Analyst Report: " Zimmer Holdings  (ZMH) stands out in a very attractive industry. The company leads several key orthopedic device categories that possess high barriers to entry and sticky physician relationships. We think these positive attributes, combined with Zimmer's manufacturing and marketing prowess, will help the firm generate excellent returns for the long run."

Quest Diagnostics 
Moat Rating: Narrow | Fair Value Uncertainty Rating: Medium| Morningstar Rating: 5 Stars

From the Analyst Report: "We think  Quest's (DGX) sizable infrastructure will allow it to benefit from favorable demographic trends and rising health-care spending... Quest and its only national competitor, LabCorp, dominate the independent diagnostic testing landscape. Both companies leverage vast national networks of laboratories and patient testing centers, creating barriers to entry and giving [them] cost advantage over regional labs."

Tessera Technologies
Moat Rating: Narrow| Fair Value Uncertainty Rating: Very High| Morningstar Rating: 5 Stars

From the Analyst Report: "The unstoppable trend toward miniaturization that  Tessera's (TSRA) chip-scale packaging technology enables and its success in using the courts to extract revenue from chipmakers much larger than itself are two reasons we think Tessera Technologies is a good high-tech investment for the more adventurous."

Penn National Gaming
Moat Rating: Narrow | Fair Value Uncertainty Rating: High | Morningstar Rating: 4 Stars

From the Analyst Report: "A series of acquisitions and favorable legislation have helped transform  Penn (PENN) from a small racetrack outfit into the nation's fourth-largest casino operator... However, uncertainty surrounding the company's pending buyout has put a dark cloud over the company's shares."

Posco 
Moat Rating: Narrow| Fair Value Uncertainty Rating: Medium| Morningstar Rating: 4 Stars

From the Analyst Report: " Posco's (PKX) technological leadership, low-cost production, and proximity to the world's fastest growing steel markets serve the company well as it strives to solidify its leading position in the global steel industry... We think Posco should continue to benefit from the global steel demand upturn for the foreseeable future."

To run this screen and see all the stocks that passed,  click here. Note: The stocks mentioned above passed our screen as of June 24, 2008. The results of the screen may change because of daily price fluctuations or other factors. After clicking, you can save the search to use later by clicking the Save Criteria button in the bottom right-hand corner of the screen. (You will need to be logged in as a Premium Member to view and save the complete screen.)