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Buy Turnaround Stories On Proven Results, Not Faith

The N in CAN SLIM stands for New: new products, new management, new potential markets. Bear in mind, new doesn't always mean starting from scratch.

Startups and initial public offerings have a whiz-bang appeal. But older companies that have restructured and reinvigorated their operations and workforces can become formidable growth stocks. Such turnarounds also benefit from established brand recognition, existing retail networks and streamlined manufacturing capacity.

Turnarounds often include bankruptcy protection or a stint under private ownership.

A well-executed turnaround converts a company weighed down by debt, a wounded reputation or sloppy management into a retooled, creative competitor. Unlike IPOs, such renewed stocks can provide common ground for both value and growth investors, expanding the interested audience — and the potential demand — for the stock.

A turnaround stock can also be viewed as a company that saw its share price and earnings ability fall apart, then reassembled itself as a new, more efficient operation. Generally, this means new management and a restructured business: units sold, debt restructured, pension plans modified.

There is often a figurehead for the process.

In 1993, Lou Gerstner joined a stalled IBM (IBM). Steve Jobs returned to a foundering Apple (AAPL) in 1997. They led two of the biggest turnaround stories through the second half of the 1990s and beyond. Under Harold Korell, Southwestern Energy (SWN) transformed from a sleepy gas utility into a leading player in the shale gas revolution.

A lot of companies out there are in the midst of turnaround attempts. Look at BP (BP), Yahoo (YHOO), Hewlett-Packard (HPQ) and General Motors (GM).

Converting a multimillion- or multibillion-dollar operation is extremely difficult. Failures are more common than success stories. Many times the failure is vague, with fundamental and stock price performance simply languishing for years.

So investors always need to demand strong performance in earnings, revenue, margins, debt and return on equity, as well as stock price behavior. Never buy a turnaround story on faith.

One of the more successful recent turnaround stories has been GNC Holdings (GNC). GNC has gained 167% since returning to public ownership in an April 1, 2011, public offering priced at 16 a share.

Netherlands-based Numico bought GNC for $1.75 billion and took it private in 1999. Sales wobbled, and losses deepened to the equivalent of nearly $10 per share before Numico sold to Apollo Investment for $750 million in 2003.

Apollo nudged up sales and narrowed annual losses to 50 cents before selling to Ares Management and the Ontario Teachers' Pension Plan in 2007 for $1.65 billion. The new owners boosted sales significantly and turned three years of accelerating profit during the recession years. The 2011 public offering earned proceeds of $240 million and, at the start of this year, Ares and OTPP held 43% of GNC's common shares.

EPS rose 65% last year on a 14% gain in sales. This year, analysts see a 47% gain in earnings and a 17% rise in sales. That's a true turnaround.