How Fabrice Taylor picks a turnaround stock

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Most investors with an appetite for some risk want big returns on their stock investments. We're talking triple-digit grand slams they can brag to their friends about. But actually achieving those kinds of returns is rarely easy.

Fabrice Taylor has had some success doing just that. Mr. Taylor wears many hats. He's a Chartered Financial Analyst (CFA), the publisher of The President's Club Investment Letter, an investment columnist with The Globe and Mail, a contributor to Capital Ideas Research, and a regular guest on Business News Network's Market Call.

Mr. Taylor's specialty is companies in the midst of a turnaround. "They're my favourite kind of investments because typically if you look back at my record on these things – Intertape [Polymer], New Flyer [Industries], Polaris [Infrastructure], IBI Group, Air Canada, which I first recommended at three bucks – they've done very well. I'm not talking double digits. I'm talking triple-digit returns," Mr. Taylor says.

High conviction, highly concentrated

Turnarounds only make up a portion of Mr. Taylor's portfolio. He owns a number of safer investments such as exchange-traded funds, and has placed some of his money with a few asset managers. But when he identifies a turnaround that meets his criteria, such as the recently recommended Colabor Group (GCL-T), he's willing to take on more risk and load up.

"This has been my most reliable, go-to investment," Mr. Taylor says. "The problem is turnarounds don't grow on trees. There's not that many of them to choose from, but usually when I find one I come away with a high conviction idea or conviction buy, and I'll typically put a lot of money into them, up to five per cent of my portfolio."

Mr. Taylor will often watch companies for a few years before buying them. When he gets more interested, he does a full month of due diligence, which includes getting to know the management team.

There are seven ingredients a turnaround company must have for Mr. Taylor to gain that conviction and buy. Let's call it a checklist:

Fabrice Taylor's turnaround checklist

1. Old company

2. Boring business

3. Lots of debt

4. Stock used to be higher

5. Improving profit margins

6. Refinancing/Restructuring

7. Attractive revenue/market cap ratio

Old and boring is good

Turnarounds aren't as risky because they're typically old businesses, Mr. Taylor says.

"There's a history there, so you can use history to gauge where the business might go. There's more reliability than a new company that's trying something new," he says "I want it to be a boring business – bus making, duct tape, manufacturing, airlines, engineering, power generation – simple things that are easy to understand and that there's always been demand for and always will be demand for. That's No. 1."

Debt can be your friend

Companies typically break down because they have too much debt and their margins start to deteriorate, Mr. Taylor says.

"That's what brings the stock price down," he says. "The leverage, the debt, works in the opposite sense when things are improving, so heavily indebted companies whose fundamentals are deteriorating, their stock prices really get crushed but, by the same token, if they're improving, the stock price goes up a lot, so I like debt."

A stock's past can indicate its future

Mr. Taylor likes companies that used to have a much higher stock price.

"It kind of confirms your sense of where it might go," he says. "Typically it won't go back to where it was. I think ITP [Intertape Polymer] once traded for $45. It's half that now but we recommended it at around a buck."

Better margins get attention

Look for improving margins.

"In every case, you've got to see the EBITDA [earnings before interest, taxes, depreciation and amortization] margins starting to improve because that's what really turns heads and gives you the confidence to buy," Mr. Taylor says. "It makes you think the debt is not so onerous."

Refinancing and/or restructuring

"Refinancing is a good thing," Mr. Taylor says.

"With IBI Group we had the rights issue and we had insider participation in that rights issue, that's obviously critical," he says "That rights issue got rid of a lot of debt. There's still a lot of debt on IBI but they got rid of just enough that [it]gave the company more breathing room along with more cash flow from better margins [and] made the debt far more manageable."

A key metric to turbocharge returns

One of Mr. Taylor's ingredients is a less obvious financial metric many investors might not consider when assessing a turnaround story: a very large amount of revenue relative to the market cap.

"For example, ITP had $800-million of revenue and a market cap of $50-million to $60-million. If you think about one per cent margins on $800-million, that's $8-million. If you're trading at $50-million, that's a very, very small price earnings ratio (roughly six times) that can move higher if they just get to two per cent net income (margins). Then you get, what I call, the turbocharged, double-barrelled return because you're going to get rising earnings but, the multiple will go up, so there's two things that drive the stock higher."

Timing a turnaround pick

Once Mr. Taylor has his seven turnaround ingredients in place, when does he buy the stock? He says he's identified patterns over the years through trial and error and that patience is important. Mr. Taylor points to his investment in Intertape as an example.

"When Intertape bounced off its lows six months after it bottomed out, and you could see the stock starting to move, and you knew it's the smart money buying it because everyone else said, 'Don't talk to me about that one. I lost so much money.' That's when you know it's bombed out. Same with New Flyer, same with IBI Group and all these other ones that I've nailed."