Some of my biggest gains have come from finding "recovery plays".
I've bought a number of recovery plays this year and I'm up more than ten per cent on them.
These are companies that have been struggling but are turning their businesses around. If you can get in early enough in the turnaround, there are potentially huge profits.
But isn't backing a recovery play as risky as "catching a falling knife"?
No - there are differences.
Catching the knife just means buying a share as it's still going down and probably reeling from various profit warnings.
A good example of that is Jarvis. It's been issuing dire statements for a long time and has been falling rapidly - but investors still buy in despite no sign of a turnaround.
There was yet another warning last Friday when the shares halved to 40p. I personally wouldn't buy the shares at 25p.
A recovery play is completely different.
I look for definite signs of a recovery in a share before buying in - rather than buying just because the share has suddenly fallen.
How do I dig out recovery plays?
It would normally be a company whose shares have dropped over a long while (maybe a year or so) by say 40%-70%. I keep an eye on a number of shares that have fallen and patience is the key to it
I would first be alerted a recover is under way by the company's share price stabilizing and then maybe starting to rise a bit.
I then like to see the company putting out statements that show it is addressing the problems that caused the drop in its share price in the first place.
I also like to see changes of personnel, and maybe a new, more experienced management team coming on board.
I look for directors starting to buy in and maybe institutions too.
If that's also followed by a company statement giving out confidence, then it could be a good thing!
A good recent example is Mothercare - the retailer that sells baby gear.
It had a torrid time between 2001 and early 2003 when it was in "catching knife" territory. It came out with profit warning after profit warning and had warehouse problems.
Shares slumped from more than 300p all the way down to 85p.
I'd kept an eye on it without buying over those years.
It came onto my radar as a possible recovery play in late January 2003 when the CEO bought shares.
That didn't convince me totally but then in March the company really started taking action and it sacked its finance director and installed a new one.
Finance director of any company is an important position and I realized the company was taking some tough action to turn the business around.
In late March 2003 the new finance director bought shares and the CEO bought more.
Now it was really on my radar - the new FD obviously liked what he saw in the accounts he was looking at.
Then in May the company reported a big loss - but with it came a statement that I liked the look of.
The CEO announced he had tackled distribution problems, improved sales costs, and was focusing on making sure his in town outlets that had been neglected boomed again.
He also closed 15 underperforming outlets and said trading was picking up.
The shares started to rise and I bought in. The share was giving out all the right signs of an excellent recovery play.
I bought at around 130p - I could have bought at 85p just a few weeks previously. But at that point I simply wasn't sure about it.
And that's fine - better to let the next man grab a few points and wait till all the signs are there than buying in too hastily.
The shares quickly ran all the way back up to the 300p area at which point I banked the rather nice profits!
So to sum up here are excellent recovery play signs to look for:
- New management coming in
- Sector returning to favour
- Action taken to stop the rot
- Directors buying shares
- Shares rising slowly and steadily
- Confident recovery statement issued
So far in 2004 a number of recovery plays have caught my eye and they are booming.
My three current recovery play favourites are Fenner, 600 Group and Brown and Jackson.
I hope retailer Brown and Jackson will do a Mothercare!
It seems to be putting in place a good recovery programme and changing its stores to a different and more profitable format. It looks like the changes are already having a good effect and I am in for the ride! I bought these at 60.7p a month ago and there's already been a rise.
Fenner, an engineering company, I reckoned was a good recovery play back in November last year - I bought at 85p and the shares have gradually gone up over 110p.
My most recent recovery buy was last week - in another engineering company, 600 Group. I bought at 69.7p after some very promising results and a confident statement and the shares are on their way higher.
All three companies I reckon are only at the start of their recovery and there is plenty more to come!