There are many types of investment methodologies out there. All of them has their own merits. I for one, personally like to invest in turnaround stocks. What are turnaround stocks? They are normally companies that are experiencing problems (hopefully short-term), and a lot of people are not willing to wait for those companies to recover.

I like turnaround stocks for two main reasons; First, turnaround stocks have problems in the open. The problem has been disclosed and our task as an investor is to figure out how much the company is worth should the problem persists or when the problem goes away. Granted, there might be more problems discovered along the way. But at the very least, some of the problems have come out and the share price generally has dropped because of that.

Secondly, the expectation is low for turnaround investment. Share price is already depressed due to known problems. The company does not have to ‘beat expectation’ every time it reports earnings. All it has to do is clear out the problems that cause its stock price to drop on the first place.

How should one find potential turnaround candidates for their portfolio? The one thing that I found useful is to read the financial news. Companies that are in trouble can be easily spotted in the news. For example, General Electric (GE) and J. C. Penny (JCP). Are these companies in trouble? Sure. Are they turnaround candidates? Possibly.

Another good source would be the list of stocks that are touching 52-week low. Most on this list would be companies that are experiencing problems and hence has the potential of turning around. For example, Sears Holdings Corp (SHLD) trades close to its 52-week low of $1.99.

I would avoid a company that is getting hammered due to the delay in its financial reporting. No matter how low the share price is, investors, do not and should not invest in companies that have some trust issues.

Once we identify our target, we can then do some analysis to determine the fair value of the stock. There are chances that some companies may never recover. So, we have to take that into accounts when doing fair value calculation. Calculating fair value is a whole brand new topic and I won’t get into the details here. But obviously, a stock will have a higher fair value if it can recover from current problems than a stock that cannot overcome its current problems.

Check out this research comparing the returns on 52-week highs vs 52-week lows