The U.S. economy is certifiably lousy, says Lynn Carpenter in Investor’s Daily Edge. Many businesses are looking for a turnaround. There are many factors affecting the success of a turnaround. A company needs to have a clear direction of what it is and where it is going. And it needs a brand name that has not been dragged through the mud. More from Lynn…

Sears’ Craftsmen tools are among the best. Sears’ appliances have always been great values. There was a time when you could go to Sears and get a pound of nails, pound of fudge and a prom dress in one easy trip. The catalog over the years weighed as much as 6 lbs and sold whatever America needed: watches, guitars, baby chicks, bedspreads, power saws, wedding rings, dolls and BB guns. It was an American icon. Sears had it all.

Yet Sears (SHLD) went bankrupt. It is barely limping back from complete oblivion along with Kmart.

Why does a company with good products and prime locations, a huge mail-order business, and status as an anchor store in very successful malls fall so badly it can hardly get to its knees? And why can’t it get back up no matter what it tries?

I think you know already. Remember the “Softer Side of Sears”? Television and print ads promoted the touchable joy of Sears’ fluffy towels, silky blouses and other home goods.

It didn’t work because Sears had long ago spoiled its own brands. The Crafstman tool quality stayed high, and that unit succeeded. But its department store goods like tee shirts, shoes and jewelry went from attractively average to below average over the years. By the 1980s, you could hardly find a clothing item in Sears that even came to the style level of competitors like JC Penney (JCP).

This is the downside of a strong brand. Let it sour enough to stand for something bad, and you will never get it back again.

I bring this up now because turnaround candidates are turning up all over the market thanks to a bad economy. One business after another has stumbled and promised that a new plan and change of management will make it all OK again. Some will make a success of their turnarounds. Some won’t.

Turnarounds are one of my favorite types of investments, but what goes into a good one is not as simple as cutting jobs, closing a few stores or plants and getting back on track.

Before all that… very first of all, you have to wonder if management even knows where the track is.

Talbot’s (ATLB) is a good case of management that did not know where it was headed or what its business was supposed to be. Any customer knew—Talbot’s sold conservative women’s clothes. That was it. While Sears had some lines of excellence going for it, Talbot’s did not have distinctly different departments. To a shopper, the lingerie, women’s casual and women’s dress clothes are all just clothes. If they weren’t all satisfying, the whole store was off. There were no Craftsman tools to be saved, only the core business.

In its women’s clothes niche, Talbot’s had an identity it aimed for—tailored classics. It did it in well-constructed clothes of good quality textiles. It stuck to that.

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But it had a design sense that was decidedly frumpy and constantly falling behind trends. It got worse and worse at being decidedly out of step as time went by. Talbot’s clothes could make Beyonce look thick-waisted and flat-chested. Sales slumped. Management decided to do something about this disaster…

It added men’s and children’s clothes.

Oh momma. If you can’t dress your primary customer, you aren’t going to make it trying to figure out an entirely different market.

For contrast, about three or four years ago, I recommended Abercrombie and Fitch (ANF), a company which mounted a spectacular turnaround. The differences between Abercrombie, Sears and Talbot’s is telling.

Abercrombie, like Sears, was a long-established, iconic American business with a big reputation. It was where the rich and famous shopped for safari, fishing and hunting gear and clothes. Teddy Roosevelt, Katherine Hepburn, Clark Gable… these were the Abercrombie customers. As was Ernest Hemingway, who killed himself with a gun he bought there.

Sales slid over the years and the stores dwindled. In 1976, Abercrombie filed for bankruptcy. Another sporting goods company bought the name and sold outdoor gear. Once again stores grew, but sales faltered. Forbes declared in 1986 that some great names were better off left to die.

But Forbes missed a big point. The name never suffered. Never.

Yes, Abercrombie’s business was badly managed, but the name never tarnished. It still stood for a store that catered to customers who “don’t care about cost but want top quality.” Then The Limited (LTD) bought the chain in 1988 and began repositioning it as an upper-tier teen brand.

That is why Abercrombie and Fitch could be revived … even with a huge change in its target clientele and its merchandise. The name never came to stand for trash. It never stood for unfashionable or cheap. It aimed for teen price ranges, but the very top of what a well-funded teen would pay. To this day, it hardly has sales except at the end of a season. It gets more full-price clothes through its stores than any of its competitors.

Think about reputation when you consider the next turnaround. There are lots of choices coming up. The economy, which is probably in recession, though economists disagree, is certifiably lousy. Lots of good businesses are feeling it. Some need a turnaround.

But some of those “turnarounds” are not victims of the economy. They were already dying businesses and ran out of ways to hide it when the mechanics of inflation or opening new stores (or the equivalent) could no longer create the illusion of growing sales.

Turnaround investing is fun, extremely challenging, and not a little bit dangerous. And the potential is wonderful—both in money and bragging rights. But it’s strictly for the brave and clear minded, because even successful turnarounds can misstep and go backwards before they go up and onwards. Abercrombie was a success story, but it took six years for Abercrombie to increase sales from $48 million to $50 million under The Limited. After that, it exploded upwards. Sales tripled over the next three years.

You can measure a lot of factors in sizing up a turnaround—credit quality, cash flow and burn rates, institutional support, inventory trends, sales per employee trends. They all matter. But the main things to measure before you drag out your calculator has to be done by a human, it is subjective. Ask these questions:

• Does this business now have a clear mission and idea what the business is?
• Does it own a clean brand or reputation in its field that has never been dragged in the mud?

Another important factor is the character of management itself. I liked Office Depot some years ago, another turnaround story, because its management set out a plan that made sense and they stuck to it. Keeping promises is very important.

Source: Looking for a Turnaround - Why Some Succeed Where Others Fail