After positive trading updates, should you buy these two turnaround plays?

The Motley Fool
Two traders looking at stock market screens
Two traders looking at stock market screens

It's always tricky buying a turnaround play. On the one hand, betting on turnarounds can be highly lucrative, but on the other, turnarounds are inherently risky and take time to play out. It's usually less risky to buy into a turnaround when the business's recovery is starting to take hold, exactly what is happening with RSA Insurance(LSE: RSA) and Dialight(LSE: DIA).


Price war

It's fair to say that these two companies have struggled over the past few years. Dialight used to be one of the London market's most promising growth companies and the shares used to command a high valuation. Unfortunately, the company's growth came to an abrupt halt when it became embroiled in a price war with competitors. Pre-tax profits peaked at £20m in 2012 and have fallen ever since as Dialight has struggled to regain its competitive edge. Last year, despite reporting record sales, the group crashed to a pre-tax loss of £4m.

However, it appears that Dialight's recovery is now on track. In a brief but informative trading update published by the company today, Dialight's management informed shareholders that trading for the year is in line with expectations.

The City is currently expecting the company to report a pre-tax profit of £10.4m and earnings per share of 20.8p for the year ending 31 December 2016.

So, after several years of problems, today's positive update from the company indicates to me that, for investors willing to take the risk, Dialight may be an attractive turnaround play.

Back on a firm footing

RSA's problems started many years ago, yet after several years of rebuilding its balance sheet and asset disposals, the company finally looks as if it is back on a firm footing. And today's results from the enterprise for the first nine months of the year affirm this view.

For the first nine months of 2016 RSA reported a 5% fall in total group net written premiums but a near £4bn increase in tangible equity. At the end of September, tangible equity stood at £3.2bn vs £2.8bn at the end of December. What's more, the group revealed in today's update that profitability for the third quarter is ahead of management expectations. Chief executive Stephen Hester also declared that "RSA is on track for strong operating earnings increases for 2016 overall."

These statements give me the confidence to say that now may be the time to buy into RSA's turnaround. City analysts expect the group to report a pre-tax profit of £341m for the year ending 31 December 2016, rising to £558m next year. Analysts also expect the group to report earnings per share of 31.2p this year and 42.6p for 2017. Based on these forecasts the company is trading at a forward P/E of 15.7 falling to 12.9 next year. The shares support a dividend yield of 2.7%, and the payout is covered one-and-a-half times by earnings per share.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.