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INVESTMENT: Recovery Stocks for the Back Half of the Year
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Recovery Stocks for the Back Half of the Year

By Michael Dow


BT 201606 070 01 INVESTMENTThere is a simply boring and age old axiom in investing which anyone can follow with ease: buy low, sell high. We've all been tempted to back the so called 'fallen angels' of the stock market at some point because we anticipate that at some point in the not too distant future these companies' fortunes will turn around and their share price will eventually return to its natural high. Some professional money managers even make it their life's work to back what they see as 'cyclical stocks', i.e. kind of asset that has a track record of being akin to a financial rollercoaster ride. They simply wait until everyone else has left the party, so to speak, and then they swoop in and buy up as much as they can, with the ultimate objective being to ride it out until things get better and share prices go back up.


Is it really a good idea to put your money behind stocks that have taken a cyclical battering? The simple answer is: yesâ€Â¦ if you know what you are doing and you have nerves of steel. It is no good to simply go 'bottom fishing', as legendary investor Peter Lynch calls it, without knowing exactly what you are getting into and what the compelling reasons are for a dramatic turnaround.


BT 201606 070 03 INVESTMENTOne common strategy that people employ is to look for a badly bruised industry then try to pick out the companies that are best placed to benefit from a turnaround in that sector as a whole. Right now the most obvious candidates are oil companies. The slide in crude prices over the last couple of years has sent the share prices of all of the big producers and distributors crashing down. Over the last year the price of BP stock, for example, has fallen by about 20%. Other big players in the oil industry like Royal Dutch Shell PLC and Exxon Mobil have also been hit hard and thus have fallen out of favour with investors. And those are just a few of the bigger market cap firms. There are lots of smaller players in this sector that have seen their share prices plummet much further.


Now could be a very good time to invest in these kinds of stocks. On the one hand there are some signs that crude prices will recover over the next couple of years. That will of course improve these firms' balance sheets. Then there is the fact that from a corporate perspective there are some very well-run companies. Gordon Gray, the head of HSBC's global oil and gas equity research team has pointed out that, "the major oil companies' progress on capital discipline, cost-cutting, efficiency gains and optimization have been impressive thus far. Although there was admittedly a lot of low-hanging fruit after several years of very high oil prices, it seems to us that the companies are serious about driving cultural change and fundamentally reshaping the industry". The aforementioned companies are perhaps the best picks for medium term capital appreciation, whilst also offering very nice dividends for people who are willing to stay the course.


BT 201606 070 04 INVESTMENT hlIn other sectors there are a few individual standouts at the moment that are looking particularly attractive because of the intrinsic value of the companies. Apple recently hit the headlines after the company's share price was down more than 30% compared to a year earlier. Of course the technology sector is becoming ever more competitive, which makes the firm's dominance harder to maintain, but at the same time this is still by far the company to back for the foreseeable future. They are consistently innovating, they always enjoy insatiable consumer demand for their products, they will benefit from the increasing middle class consumption in emerging markets and on top of all that they have a very good management team. Moreover, it is worth mentioning that they are diversifying their corporate portfolio, by investing in other strong companies like Chinese taxi app designers Didi Chuxing.


BT 201606 070 02 INVESTMENTBanking behemoth HSBC is also a very promising stock for future capital appreciation that has fallen by 30% over the last year, making it a potential bargain for savvy investors. Admittedly with the slowdown in China looking set to continue there will be some turbulence for a while, but that shouldn't be turning people off to the extent that it has been in the last few months. Of course, 'slowing' is all relative and the world's second largest economy continues to grow at over twice the pace of any developed nation. With HSBC being extremely well-positioned to benefit from this growth, its top and bottom lines could rise at a brisk pace over the medium to long term. What's more, HSBC has also fallen out of favour with investors due to its lack of cost control. While a number of its peers have reduced staffing numbers considerably and cut operating costs, HSBC's costs are at record highs. To address this it is implementing various initiatives which should make a real difference to its cost: income ratio and, with HSBC trading on a price to earnings (P/E) ratio of just 9.8, there is huge scope for a major recovery in 2016 and beyond.


There are bargains waiting to be discovered in every stock exchange on the planet. At the moment though, it has to be said that the UK in particular has plenty of fallen angels that have a lot of potential upside. In the last couple of decades shareholders in Tesco PLC have had nothing but heartbreak as the former darling of the British retail sector has seen its share price cut in half. Now it is cheaper to snap up Tesco shares than it has been for years, which might well be a good idea if CEO Dave Lewis' drastic turnaround plan succeeds.


Other honourable mentions are fashion powerhouse Burberry and vehicle recovery firm AA. Like many other firms, Burberry has been hit hard by slowing sales in China. With it being a key market for the business this is set to hit its financial performance in the short run, with Burberry's net profit expected to fall by 6% in the current year. However, it is forecast to bounce back with positive growth next year and, for long term investors, its current P/E ratio of 16.9 has huge appeal while a number of consumer goods companies trade on considerably higher P/E ratios. In the long run, Burberry is likely to grow sales at a rapid rate as a result of its very strong brand, the scope to diversify into new product categories and also price increases. These factors, alongside a recovering developed world and a rising emerging world, mean that now appears to be an excellent time to buy a slice of it. AA has seen a third of its share price wiped out and it too looks like a really good bargain compared to its competitors.


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