Wait for the “V”

It really is tough trying to pick turnaround stocks. This strategy can be very profitable, but the investment risks are high.

The vast majority of individual investors want to buy shares in companies whose stock prices are very low. I guess it is human nature, but in my experience, most individual investors want to buy shares in companies with stock prices trading below $5 per share.

This is a valid strategy, but if it was my portfolio, I’d mix things up a bit.

From what I’ve seen in ten years of following the stock market on a daily basis, it is just as easy for a $15 dollar stock to double to $30 per share, than it is for a $3 stock to go to $6 per share. In fact, it is often more difficult for the lower priced stock to go up in value.

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In many cases, stocks that trade for under $10 per share are smaller companies that have perhaps had some operating difficulty. Most new initial public offerings (IPOs) of equity occur at prices over $10 per share, so very often a stock trading below this level is indicative of some trouble.

With this in mind, opportunity can easily present itself at this price point. Consider one of my favorite companies, Perficient Inc. (NASDAQ/PRFT). This company sells information technology consulting services to large- and mid-size companies, offering design, build and delivery of eBusiness solutions. Perficient was founded in 1997 and is headquartered in Austin, Texas.

The stock got hit hard after the technology correction and dropped from over $25 per share in early 2000 to below $1 per share in late 2002. Then, it started to tick higher, slowly but surely. If the company’s valuation was overblown during the technology bubble, it was also overblown to the downside in its correction. Business wasn’t that bad three years ago, only flat.

Right around early 2003, the stock reversed itself and began to rise. At $3 per share, Perficient’s stock chart showed a significant “V” pattern, indicating that the company and stock market was now more enthusiastic about its prospects. Now the stock is at $12 per share and business is great. I wouldn’t be surprised to see the stock hit $15 per share in the near future.

So, if you want to be picking a turnaround situation, look for a defined “V” pattern first. Yes, you might miss out on getting in at the bottom, but it is almost impossible to get in at the low regardless of how well you know the stock. When it comes to turnaround investing, wait for the “V” pattern to show itself. The market will have already corrected itself and the probability of more upside becomes greater.