While it would be fantastic if all stocks within a portfolio were to perform well all of the time, the reality is that all businesses endure challenging periods. After all, the business cycle combined with changing customer tastes and the addition of new technology means that earnings numbers never follow a perfectly smooth, straight line for any company in the long run.
Of course, when a company endures a challenging period it tends to hurt its share price. Not only do earnings tend to fall, but the reputation of the stock in question can take time to recover among the investment community – particularly if it is felt by investors that the company's actions (or lack of action) contributed to its worsening financial performance.
However, the potential for turnaround in such stocks is huge and, so long as there is a wide margin of safety on offer, the risk/reward ratio can be appealing. For example, QBE Insurance Group Ltd (ASX: QBE) endured a challenging period in recent years, with its bottom line slipping into the red and the market becoming rather unexcited regarding its future potential. Furthermore, investors became somewhat dismissive of QBE's earnings guidance, since they felt as though downgrades were all too common. As such, QBE's share price fell by 39% between the start of 2011 and the end of 2014.
However, in 2015, it has risen by a whopping 31% as QBE has begun to deliver on its ambitious turnaround programme. For example, it has divested non-core assets that were deemed to be either too risky, lacking sufficient reward or which did not allow the company to focus on its most profitable areas. And, with considerable efficiencies coming through, QBE is becoming a leaner and more profitable business that is forecast to post earnings growth of 62% during the next two financial years. Furthermore, with QBE trading on a price to earnings growth (PEG) ratio of 0.7, additional capital growth is very much on the cards over the medium term.
Meanwhile, health care device producer, Cochlear Limited (ASX: COH), has also endured a rather difficult period. Its share price fell by 27% between the start of 2011 and the end of 2013 but, with a handful of new products now coming through, there has been a major resurgence in investor sentiment and it is up 16% year-to-date.
Looking ahead, Cochlear's net profit is forecast to rise by 97% during the 2015 and 2016 financial years which, if met, could be a game changer for the business. That's because, while at least some of this growth is currently priced in, Cochlear's PEG ratio of 0.8 indicates that its shares have much further to go.
And, with many investors seeking out stocks that have relatively low correlation with the wider index and the Aussie economy, Cochlear seems to offer an appealing investment case, while a beta of just 0.5 means that its shares should offer reduced volatility, alongside superior performance, versus the ASX over the medium term.
