This is what makes the NCAA basketball tournament a big event each year. I bet many of you have even participated in one of the online fantasy tournaments where you pick teams in each bracket with the hope of guessing the Final Four correctly.
Every year the tournament has its upsets with a #14 seed beating a #3 seed. The problem with filling out the bracket is, how do you know who is going to be the Cinderella team?
This year, Florida Gulf Coast became only the seventh #15 seed to beat a #2 seed in tournament history. It was also the first #15 seed to make it to the Sweet Sixteen.
Be honest. You didn’t pick Florida Gulf Coast to win its first game in your bracket, did you? There’s always one team that no one really foresaw getting it together just in time for the Big Dance. Trying to guess who it will be is part of the fun of watching.
Stock picking can be a lot like filling out the NCAA bracket. There are plenty of #1 seeds and everyone knows who they are. Those big guns are companies like Apple and Caterpillar. If you invest in one of them, odds are on your side.
But how do you find the Cinderella stocks that are the #9 seed but play like the #1s? These are stocks that are flying under the radar. They may be turning around their business, but investors aren’t paying attention yet.
These stocks, like the #9 seeds, may look similar on paper but some will have the special magic to break out of the pack.
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Certain unloved companies have suddenly leapfrogged from low Zacks Ranks to the highest #1 “Strong Buys.” But only a few are true Cinderella stories that will jump in price and build substantial gains for weeks to come.
Today, you can see the handful of gems from a powerful strategy that adds valuation and aggressive growth factors to the mix. All 8 of its current recommendations are already in the green, and you can get to them before other investors spot the turnarounds and drive the prices higher.
3 Ways to Find Stocks That Are About to Be Cinderellas
1) Look for Winners
To be a Cinderella story in the NCAA tournament, you have to win. (Obviously!)
For companies, though, the winning begins when its earnings history starts to turn around. Many times, the analysts are slow to recognize that there is a change in the trajectory in the company, so the company starts easily surprising on the estimate every quarter.
Winning, then, is a company putting up big earnings surprises or a streak of them. When this happens, the analysts will then usually start raising their own estimates in expectation of better things still to come. This good news leads to rising estimates and, hopefully, earnings growth.
Choose stocks that have rising estimates.
2) Buy Growth Stocks
Companies that are turning it around can be found in any sector. They can be big or small. But the best returns come from buying the stocks that have the highest growth rates. That is because once the turnaround takes place, the PE will start to rise from abnormally low levels. The higher the growth rate of the company, the more the multiple will expand and the greater your final return.
Focus on growth stocks for the best turnaround profits.
3) Value Is Still King
Not every cheap stock is a bargain. Fundamentals, such as rising earnings, still matter. A company may trade for a $1 but if it’s just days away from bankruptcy then it’s probably not a good turnaround possibility.
In the NCAA, the bracket busters almost always come from a Cinderella team. It’s not risky to pick all four #1 seeds to make it to the finals. But betting on a #9 seed to make it there? That takes a lot of guts.
It also takes guts to buy a turnaround stock, but you can cut down on the risk by buying one that is trading at a discount to its peers. I use low PE, PEG and Price-to-Book ratios as a way to find value.
Where to Find Cinderella Stocks Right Now
Turnarounds can easily be detected when a company’s earnings estimates suddenly reverse from downward to upward.
So the proof of the turnaround occurs when a stock makes a sudden leapfrog from a lowly Zacks Rank #5 (Strong Sell), a Zacks Rank #4 (Sell) or a Zacks Rank #3 (Hold) all the way to a Zacks #1 Rank (Strong Buy).
I manage a Zacks strategy that monitors such moves and adds valuation and aggressive growth factors to the mix. Right now, this Turnaround Trader has 8 out of 8 recommendations in the green, and I look for them to move a lot higher. If you would like to see them and be notified of new turnaround stock recommendations, there is now a unique way to do it. In fact, you can see all of Zacks’ private buys and sells for a total sum of $1.
Get details about Turnaround Trader and a special $1 opportunity.
Tracey is Zacks’ Value Stock Strategist and is also Editor in Charge of our Turnaround Trader and Value Investor stock recommendation portfolios.