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Tricks Of The Turnaround Trade: An Interview With George Putnam Of The Turnaround Letter
Seeking Alpha recently shared this "deep-dive" Roundtable interview with George Putnam.
- George Putnam of The Turnaround Letter joins the Roundtable to talk turnarounds.
- Even with the S&P now soaring over 2,800, there are still turnaround opportunities to be found.
- George shares two top ideas: GE and an oilfield services company, WFT.
Investing in turnaround situations can be tricky. As the old adage goes: "Turnarounds seldom turn." That said, for investors who are willing to patient and wait for the turnaround to come to fruition, the returns can be potentially quite rewarding. That said, even with a gallon of patience, turnarounds are not for everyone.
Even still, George Putnam III (yes, from THE Putnam family) has made a career out of investing in turnaround situations. Despite coming from a family of investors, he actually started out as a corporate lawyer. However, after recognizing the profit potential of turnarounds, he switched gears and founded The Turnaround Letter more than 30 years ago. He hasn't looked back since.
We asked George to join us on the Roundtable to discuss the risks and rewards of turnaround stocks, elaborate on his General Electric (GE) thesis, and share his current top ideas.
(Editor's Note: these questions were originally written on November 7, 2017)
Seeking Alpha: For the few who don't know who you are, your grandfather, George Putnam, is the founder of the mutual fund company, Putnam Investments. As your family name indicates, you have quite the investing pedigree. How did you come into investing, and what did you learn from your family? What did you do differently?
George Putnam: You are correct. My grandfather founded the first "balanced" (meaning that it held both stocks and bonds) mutual fund in 1937.
I actually began my career practicing corporate law with a large firm based in Philadelphia. One of the larger legal projects I worked on was helping the old Reading Railroad (of Monopoly board fame; the successor company is now called Reading International) out of bankruptcy in the early 1980s. From that experience, I realized that bankruptcy securities, post-bankruptcy stocks and turnaround situations are not well understood by most investors, and so they are often undervalued in the stock market. I began to study bankruptcy and turnaround investing and began doing it on my own in the mid-1980s. Eventually, I left the law firm and started The Turnaround Letter in 1986.
One of the most important investing lessons that I learned from my grandfather and father is the importance of diversification to reduce risk. However, my focus on turnarounds and troubled companies differs from the approach of the rest of my family. I consider them to be largely conventional investors.
SA: Your specialty is turnaround opportunities. What is it about these companies that makes them compelling investments for you?
GP: I believe they represent a relatively inefficient niche in an otherwise pretty efficient stock market. And this inefficiency leads to potentially high returns. The inefficiency has several causes: 1) many people don't understand what goes into a turnaround; 2) the recent history of a turnaround candidate can make it hard for mainstream investors to analyze; for example, it is hard to look at relative P/E ratios when the company has had negative earnings; 3) turnarounds usually take time and therefore require more patience than many investors seem to have; 4) for all of the foregoing reasons, brokerage firms and other investment services are not usually willing to recommend turnaround situations; they prefer "safer" recommendations.
SA: What are the risks of investing in turnarounds? How do you mitigate those risks?
GP: The biggest risk is that the turnaround doesn't happen. There are several ways to mitigate that risk. The first way is to diversify. If you invest in a number of turnaround situations, the profits from those that do successfully turn around are likely to more than offset the losses from those that don't. Second, focus on potential turnarounds that do not have too much debt. If the company has a decent balance sheet, that gives it a long runway to produce a turnaround. A heavy debt load increases the chance that the company may end up in bankruptcy, which usually makes the stock worthless. Third, if the company has a good (and sustainable) dividend yield, you will get paid something while you wait for the turnaround to take place.
SA: You recently wrote an interesting thesis on the blurring of the lines between private and public equity, and what that means for investors. What opportunities are you seeing in the markets currently as a result of this trend?
GP: This trend is likely to have a greater effect on growth stock investing rather than turnaround investing because growth companies may wait a long time to come public - or may never come public. If the trend continued for a long time, it might reduce liquidity in the stock market by shrinking the number of publicly traded stocks too far. But I don't see that happening anytime soon.
SA: As you aptly observed in a recent article on General Electric, the company is a bit of a "hot mess," to use a colloquialism. Shareholders are selling in droves, the stock price is down 14% since July earnings (as of October 16, 2017, when you posted the article), (former CEO) Jeff Immelt left earlier than expected, and sentiment is largely negative. Yet you recommend GE as a buy. You're a big believer in new CEO John Flannery. What do you see that others don't?
GP: A new CEO is often an important catalyst for a turnaround. The leader who leads a company into trouble usually will not be able to lead the company back out again. Also, we like to see companies - especially, big sprawling companies like GE - focus on their best businesses and jettison ancillary lines of business. This is exactly what GE is doing under Flannery.
SA: Let's talk macro trends. At the time of this writing, oil prices are surging toward their 52-week highs (based on the United States Oil ETF (USO). The Market Outlook headlines on Seeking Alpha are largely bearish on the market, and there seems to be an abundance of worry about when, exactly, the next correction/crash/recession will occur. What is your view on the markets and where they're headed?
GP: My strongly held view is that you should not try to predict where the market is going because even the smartest people usually get it wrong. If you try to time the market, it is likely to be very detrimental to your long-term returns. Even if you succeed in cutting back your exposure before a downturn, it is unlikely that you will succeed in getting back in at the right time and may miss the next rebound. There is an old saying: "You can always tell the market timers - they're the ones with the holes in their shoes."
SA: As a follow-on to that, how are you positioning your portfolio((s)) to protect against an abrupt and/or severe market downturn? Or how would you suggest investors position themselves?
GP: I believe that you should put as much money into stocks as you can without losing sleep over the market, and then stick with that allocation for the long haul.
SA: Are there turnarounds available with the S&P 500 near 2,600? Or put another way, what does it say about companies that are struggling this late in a bull market, and does that affect how you look at them?
GP: There are always good turnaround opportunities available, but they can be harder to find when the stock market has been soaring. In any market, you have to look at a potential turnaround, figure out what caused its problems, and then decide if management is doing the right things to fix the problems.
SA: What is one investing opportunity you're particularly bullish on currently, and what about it makes it appealing?
GP: Because I believe so strongly in diversification, I hate to zero in on one particular stock. But that said, I really like an oilfield services company called Weatherford International (WFT). Under its flamboyant former CEO, it made a lot of acquisitions, mostly financed with debt. It did not do a good job of integrating those acquisitions, and so when oil prices fell sharply in 2014, Weatherford was inefficiently run and burdened with a significant debt load. A new CEO took over in early 2017, and he is streamlining operations, getting rid of non-core businesses and reducing debt. At the same time, oil prices are rising again creating more demand for Weatherford's services. All that said, Weatherford still has a heavy enough debt load to make it somewhat risky.
More conservative turnaround investors should look at General Electric, which has a stronger balance sheet and is taking the positive steps noted above. Also, even after its dividend cut, GE still has a decent 2.5% dividend yield.