From Rags To Riches.
A company that’s currently doing badly, but has the potential for a turnaround, is a diamond in the rough.
It can be very lucrative to find one of these and correctly identify when the company is turning around into something much more profitable.
Today we’re going to take Domino’s Pizza as an example of the ultimate turnaround story:
In 2007, the stock of Domino’s traded at about $32. In 2010, 2 years after the financial crisis, it went down to $9 dollars and was struggling to recover like many other stocks. Today, the stock is an eye-watering $517.
This means that investing 1000 euros in 2010 in Domino’s would be worth about 55–60k today, 11 years later! DAMN.
Why is a turnaround story so lucrative?
In the stock market, a stock performs well not just because the company is a good quality company with large growth potential. The valuation also matters.
Valuation by investors takes into account assumptions on what they think profits will be like in the future. Stocks go up when the real profit achieved is higher than the assumptions, and likewise, Stocks go down when the real profit achieved is lower than their forecasts.
So what matters is not how big profit will be, but how much bigger are the profits when compared to the expectations!
It’s not good to grow profit by a strong 25% if investors are expecting 30% — the stock goes down.
A turnaround is so lucrative because at the time of the turnaround, investors expectations are very low, often anticipating falling profits. The company isn’t being run very well, and at this point, valuations are likely to be low.
This is however, a good opportunity if the management have a plan. This is because it’s a low-bar to beat these expectations. In fact, Expectations can be so low that even average profit growth will shoot the stock up.
If the company is already doing very well profit-wise, the bar is set very high. Thus its very likely that the valuations have already priced in all the goodness of a stock, hence, if a company does beat the estimates the share prices might move ever so slightly as investors would have already expected such performance.
What you want to be doing in this case would be looking for a very bad company with a plan to become a very good company to capitalise big.
You’re looking for a very bad company with the plan to become a very good!
What happened to Domino’s?
Around 2010, Domino’s pizza was ranked as having one of the worst quality pizza’s on the market. It was just a generic pizza brand, there was no reason for anyone to specifically seek out Domino’s. Then, management had a plan to change it all around.
Management addressed all the negative reviews head on by admitting all their flaws and fixing them, and even creating a better offering than the competition. The quality of pizza soon became much better and their best achievement was the technology offering they had.
Nowadays we can see how everything is going digital but back then it was less common to have orders online. They were an early mover for pizza companies in allowing orders to be done over a website or an app, where you can even track your order. Early movers for new ideas are usually the ones that benefit most from it, it’s what they become known for.
What should I look out for?
When spotting a turnaround, the biggest factor is the management. The CEO is often going to say nice sounding stories to convince you that the company is going to be turned around but you’ve got to be able to see through the story.
— Does the CEO’s plan make sense?
— Is it realistic?
— What’s their track record?
— Can competitors easily copy this idea and do it even better?
— Are the management building competitive advantages?
— Are they trying to be great at few niches or are they average at everything?
These are all questions to ask yourself. There are many potential turnaround stories that might never succeed.
But find that one that is believable, and you may be sitting on a goldmine.
If you’re interested in joining us on our journey, join our Facebook group: The Investment Hub — Malta
Any views or opinions presented in this article are personal and shouldn’t be taken/used as professional advice as we are not qualified financial advisors.
Any statistics mentioned have all been linked to their respective documents together with their ownership.
Lastly, we would like to note that this article has no tie to our professional jobs and was conducted in our free time.