Duck Disaster And Give Your Momentum Stocks A Health Check

20th Nov '13 by Ben Hobson

6 comments 15960 reads

Momentum investing strategies have been big winners this year, helped by conditions that have propelled many share prices to dizzying levels. While commentators are divided on when a market correction might hit, investors would be forgiven for being wary of using pure price strength as a buy signal given that so many shares have surged this year. For those that have ridden the momentum wave, now could be the time to reassess whether some of these stocks have run too far and could be poised for a fall if markets do take a dip.

Among the best performing momentum strategies tracked by Stockopedia over the past year is James O’Shaughnessy’s Tiny Titans, which has returned 61% before costs. That exceptional performance is partly down to the fact that the screen specifically looks for companies in the £15 million - £150 million market cap band. Small caps have been huge beneficiaries of the bullish conditions in 2013 and Tiny Titans shares many of its qualifying stocks with the FTSE Fledgling XIT, which itself is up by an impressive 43% over 12 months.

Trending Value

Tiny Titans was first presented by O’Shaughnessy in 2006 as a way of finding under-researched small-caps that look cheap based on their price-to-sales ratios but with strong 12-month relative price strength. More recently, O’Shaughnessy has rewritten his rules for finding undervalued shares, preferring instead to use a blended range of valuation ratios (which is similar to Stockopedia’s ValueRank) in a ‘Trending Value’ strategy. His studies of past returns have found that “a composite that combines several different value factors delivers stronger returns and more consistency than any individual factor”.

Combining value and momentum meant that Tiny Titans was able to get in early with stocks like Staffline (LON:STAF), Regenersis (LON:RGS), Telford Homes (LON:TEF), H.R. Owen (LON:HRO) and Helphire (LON:HHR), riding their impressive gains through most of this year. Importantly, it hasn’t been the only value and momentum screen to work well in these conditions (I wrote about a similar strategy last week) and the entire format is acknowledged to be an effective way of outperforming the market.…

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Paul Scott

21st Nov '13

Hi Ben,

Interesting article, thanks.

I think Momentum on its own is very dangerous - people get comfortable at exactly the point that they should be getting nervous. So the inherent flaw with Momentum as a strategy is that it will work, until the point where it goes horribly wrong.

Momentum combined with gearing is catastrophic, as I learned to my cost in 2007-8. Momentum is often accompanied with hubris, in that people who have been right through every dip, think they will be right forever (again, got the T-shirt).

So just be careful with any momentum-based strategy, as the kings of today will be the paupers of tomorrow, when the next big market downturn happens.

The ideal position is to sell high, and hold some cash at the late stage of a bull market. But above all, at the start of a bear market, not have any gearing at all, and have plenty of cash, then sit on it. The momentum traders will almost all have gone bust well before the bear market ends, and the value players hoover up the incredible bargains that only people who have cash can buy at the depth of a bear market.

Most good companies have doubled in price in the last 2 years. So why on earth would we want to buy them now? It's crazy!

HOWEVER - if the fundamentals of the company have improved more than double, then the valuation is actually cheaper. So take Vislink. It was a bit of a basket case at 30p. Now it's trading far more profitably, so the price is arguably cheaper at 48p. So momentum ignores that completely.

Conclusion - just looking at share price alone, whilst ignoring fundamentals, is bonkers. You need to look at both. If it's gone up, and the fundamentals have also improved, then the price rise is justified. If it's gone up but nothing has changed, then it's just got more expensive, so BLASH says should probably be sold.

Cheers, Paul.

Ben Hobson

Hi Paul,

I couldn't agree more. Most of the momentum strategies that Stockopedia models do actually combine price strength with one or more of value, growth, earnings surprises, broker upgrades, etc.

Earlier this year, literally the start of 2013, some of these strategies were beating everything else. 11 months on the momentum waters have been seriously muddied. I guess it's just important to remember what was making some of these shares attractive in the first place and examining whether that still exists. Hence the addition of the Quality+Value Rank (above). It's a quick look at whether a once apparently undervalued share that had turned a corner now looks overvalued and of questionable quality. Or the reverse, as you say, with Vislink.

Cheers, Ben

Edward Croft

Paul - spoken like a true value investor !

I think Momentum is fascinating because it's actually historically proven to be the most predictive selection factor of all across almost every asset class - commodities, currencies, stocks, bonds you name it. It's even more predictive than Value. There are lots of mega hedge fund millionaires out there that prove this point. It's just that the drawdowns to long/short momentum can be quite vicious.

Value investors hate the idea that buying momentum works, because it's the antithesis of everything they believe in and seems so completely brainless compared to the intellectual appeal of value investing, but I think that misses the point.

There are 2 different driving powers at play in price movements. Mean reversion and Trend Continuation. Value investors tend to focus on the former, momentum investors the latter. As this phenomenal paper by AQR Capital shows Value + Momentum has better returns at less risk than either on their own. One zigs when the other zags. Value investors clearly could improve their returns by being a little less sniffy about momentum investing. Remember Tony Dye? He was a die hard value investing fund manager who lost his job in the dotcom bubble - sometimes, you have to have a balance and admit that there is value in momentum in that it sometimes predicts the future.

Chasing momentum is something else completely. Would I buy £ASC now? Hell no. Frankly I didn't buy it last year either - but clearly I should have. I'm too much of a value investor to buy things like Blinkx and ASOS that are at the nose bleed end of the valuation spectrum, but perhaps I should change my mind.

DJLJ23

If your buying into momentum, I think you need to understand the business to some degree (unless your in for the short term) . For instance I like WANdisco (LON:WAND) because its product is essentially high margin software, with a customer pay back (according to an analyst report, I published link on previous posting) of < less than 3 m, Its difficult to see how any company with multiple country development environments, would not want to use it. I'm sure their are competitors, but not that many

£AGM, don't understand it, but expected lots of excitement (grapheme being the next big thing) after 24hrs have reduced holding to take profits, now actual stake pretty small, we shall see where it goes.

£ASOS however is different yes its expanding fast, and my wife tells me, the girls in her office are on it every lunch time, but as Paul Scott pointed out, Debenhams online offering is nearly half that already, so catching up fast. From a competitor perspective, there are lots out there.

I think in the current market most peoples portfolio will benefit from including some momentum stocks, under pinned by good fundamentals, but i'm definitely of the view diversify to reduce risk and not let the speculative stocks take over your portfolio. For me that would just be to much stress, I want overall 30% +, year in year out, not +50% today and -30% tomorrow.

many thanks for a great service, yesterdays talk was so much better than the previous ones, not from a content view (which was good) but because I heard it all clearly. looking forward to more.

DYOR

David

cig

The WANdisco core product is open source software. You can download it for free. You don't need them at all. Lots of people use this software and I'd estimate 99% don't even know WANdisco exists. They sell add-ons of most dubious value for a narrow niche, for which cheaper/free solutions are most likely available, so my guess it's mostly sales driven hot air which looks like high margin to gullible investors. (Well technically it is high margin, the cost of goods for hot air is pretty cheap, it's just not very sustainable.)

22nd Nov '13

Thanks Cig,
Not sure about gullible investors, you may have the technical knowledge to say "The king has no cloths on", but from a business perspective the likes of IBM, SONY, YAHOO, CISCO and many others, will have done a considerable amount of due diligence before committing their business to using the products and presumably they like the IP that WANDISCO wrap round the service. The business may be overvalued, but i'm happy to sit in on the ride for the moment, but i'm not putting the house on it, after all the possibility that somebody else, might come up with something better is always there.
Extract from Forrester report
"The findings of a recently commissioned Forrester Consulting Total Economic ImpactTM (TEI) study of WANdisco's SVN MultiSite. Forrester's TEI methodology measures costs and cost reduction and weighs the enabling value of a technology in increasing the effectiveness of overall business processes. The subject of the study was a Fortune 500 company with annual revenues of over $5 billion, with SVN MultiSite in production in the US, UK, and India. Forrester concluded that SVN MultiSite generated a return on investment (ROI) of 357% with a payback period of less than 2 months."

Duck disaster and give your momentum stocks a health check

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Ben Hobson

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