Some of the biggest profits can made through buying shares in companies that have endured a difficult period but that are at the start of a potential turnaround. Certainly, it can mean that paper losses are made in the short run, but in the longer term it can also equate to a high level of capital gains.
The turnaround kid
With Rolls-Royce (LSE: RR) being at the beginning of its own turnaround story, many investors are interested in buying a slice of the engineering company. This seems to be a logical move since Rolls-Royce has an excellent management team, is financially sound and has the potential to benefit from a growing aerospace market in particular.
The problem, though, is that Rolls-Royce appears to be rather expensive at the present time. For example, it trades on a forward price-to-earnings (P/E) ratio of 19.5, which indicates that its shares could continue to come under severe pressure even after their fall of 34% since the turn of the year.
And with the company’s bottom line due to fall by 20% this year and by a further 43% next year, 2017 could see further losses being reported. As such, it may be prudent to wait for either a lower share price or an improved outlook before piling in to Rolls-Royce.
Good times ahead?
Also set to have a difficult year is Royal Mail (LSE: RMG). Its bottom line is forecast to decline by 20% in the year to the end of March 2016 and while its shares have risen by 3% in 2015, they could come under pressure in the coming months as the market prices in the expected disappointment from a net profit decline.
However, Royal Mail also offers excellent upside potential in 2016 and beyond, with the 2017 financial year set to deliver a rise in the company’s earnings of 10%. With Royal Mail trading on a price-to-earnings growth (PEG) ratio of 1.2, this upbeat growth potential does not yet appear to be priced-in, which means that its capital gains could be very impressive by the end of 2016.
In fact, if Royal Mail were to rise by 25% next year, it would still trade on a P/E ratio of 14.8 which, for a company that offers double-digit earnings growth potential, does not appear excessive.
Stability play
Meanwhile, National Grid (LSE: NG) continues to offer one of the most consistent and reliable growth outlooks in the FTSE 100. While its shares trade on a P/E ratio of 15.2 and offer little in the way of strong earnings growth prospects over the next two years, National Grid’s income appeal remains very high.
For example, it currently yields 4.8%, which is around 20% higher than the FTSE 100’s yield. Plus National Grid offers much greater resilience than the wider index during challenging economic circumstances. The index has a relatively large exposure to the resources sector and the financial services sector, both of which could prove to be volatile in 2016. In fact, with a beta of 0.75, National Grid clearly offers a less volatile shareholder experience than the wider index.
If National Grid’s share price were to rise by 25%, it would still yield 3.8% and continue to offer a more robust outlook than the majority of its peers. Therefore, if US interest rate rises hurt investor confidence next year and the Chinese economic slowdown gathers pace, National Grid could become more in demand and its shares could easily be bid up by 25% or more.
