The astute investor can make substantial profits from the apparent aversion of other investors to distressed situations. The potential for profit does come with significant risks. Because many prospective turnarounds do not turn into success stories, one must diversify to mitigate the downside risk. Information on troubled companies is hard to come by and hard to analyze. After fully analyzing the information available on a particular distressed situation, the investor is still faced with a large degree of uncertainty.
Time is also a factor.
If the company reorganizes under court protection, the restructuring process can take several years. If the company manages to avoid bankruptcy, it may still take the stock market as long as five years before it recognizes a successful turnaround. The key to turnaround profits, of course, is separating those companies that will recover and return to favor from those than will not. In the first section, Company Selection, we discuss several key indicators to look for. Once a prospective turnaround is located, you must select specific securities according to the particulars of the restructuring.