How to avoid High Flyers about to hit turbulence

We all know the feeling. An otherwise smooth flight is interrupted by a couple of bumps. We hear a bing-bong, and the seat belt sign comes on. The cabin crew ask us to return to our seats. We are in for a rough ride.

It is the same for our high-flying investments. High-quality companies with strong momentum can be one of the fastest ways to reach our investing destinations. However, they also come with a significant risk of turbulence. Companies that are flying high have much further to fall when atmospheric conditions change. With turbulence on a plane, we are along for the ride, whatever comes our way. Not so with our investments, where we are mainly free to sell whenever we choose. Is it possible to get out at the right time?

Is there a bing-bong moment for high-flying investments?

There is a market saying that “nobody rings a bell at the top or the bottom of a market”. This is true. No investor consistently gets in at the bottom and out at the top. However, investors who get out when the seatbelt sign comes on following those first few bumps will do much better than those who need to reach for the sick bags.

Given the value of this potential insight, the team at Stockopedia have spent a significant amount of time trying to answer this question. A few weeks ago, I looked at the effect of investors avoiding the lowest-ranked stocks on their least preferred measure. The answer was pretty clear for Contrarian investors who like cheap, high-quality stocks. They should fight their urge to go completely against the crowd and would do better (at least in our simulations) by avoiding stocks with terrible momentum characteristics.

However, the case for investors in High Flyers avoiding the lowest Value-ranked stocks is not as clear-cut. There are times when this would have worked (most notably during the recent weak UK markets). However, overall, there was no clear advantage to this, as the following chart, which splits high QM stocks into V-quartiles, shows:

Last week, Roland asked if falling Momentum could be a warning sign of trouble ahead. He gave interesting examples of Bunzl (LON:BNZL) and Celebrus Technologies (LON:CLBS) , where the drop in Momentum Rank signalled concern before some big falls in the share prices. However, when he simulated the effect of falling or rising Momentum Rank on long-term theoretical returns, there was no clear pattern:

In this case, the absolute Momentum Rank seems far more predictive than changes in Momentum Rank. However, I think there are some limitations to these results. They are based on the semi-annual rebalancing of portfolios across the whole universe of stocks (in this case, all UK stocks since 2014). To answer this question for individual stock picks, I think we need more granularity. Let me demonstrate with a popular example:

A case study: Warpaint London (LON:W7L)

I have already written about how it appears to me that selling a High Flyer when it becomes a “Falling Star” is too late. In this case, by the time the Stockopedia algorithms classified this as neutral, let alone applied the negative classification of “falling star”, the bulk of the recent losses would have been suffered:

This medium-term chart also demonstrates the folly of some other strategies that may seem intuitively correct. Firstly, Warpaint London (LON:W7L) was rarely a Super Stock. By the end of 2022, the company had high returns on capital and good fundamental Momentum. However, the low Value Rank meant this was firmly a High Flyer for most of its upward journey. Investors who were put off by the low Value Rank (including me!) missed out on a 6-bagger in two years. This is an example where a strategy of avoiding stocks with very weak “least preferred” ranks would be a losing one.

Secondly, the peak of the share price was pretty much the peak QM Rank. Relying on this as a sign to exit at the high point looks nigh on impossible. When the Stock Ranks are relative measures against other stocks in the universe, how high is too high? is a question the ranks simply can’t answer.

A closer look

To try to get a better insight, I asked Alex for the price and Stock Rank data for the year before and after the share price peak (or as up-to-date as possible). The ranks don’t tend to move that quickly, so here I have graphed the data weekly:

I have set the share price peak to be at Week Zero and scaled to be 100, so all share price movements are relative to this value. This is so that comparisons can be made to other stocks, which will have different share price peaks in terms of value and time. This also gives a reasonable scale to compare the Stock Ranks, which obviously range from 0 to 100.

From this more granular approach, it is clear that the Quality and Value Ranks are not particularly useful for decision-making here. The Quality Rank has remained high throughout. While the Value Rank was close to its low at the peak share price, it was at a similar level 10 weeks before that. Investors who used this as a signal to sell would have sold below the level of the recent share price collapse.

Two things stand out as useful signals. The first is that the share price increase accelerated shortly before its peak. From research into financial asset bubbles, for example, in research papers by Professor Didier Sornette, we see that very rapid price growth, so-called super-exponential growth, is a warning sign for unsustainability. While it is hard to say if that acceleration was super-exponential here, short-term acceleration was perhaps a warning sign. However, the major portent of poor future returns is the divergence between the Momentum Rank and share price. The Momentum Rank fell precipitously seven weeks before the share price mirrored this behaviour.

Could fundamental analysis have helped?

As a largely bottom-up fundamental analyst, I’d like to think that my analysis would add value to this sort of situation. However, in reality, this appears not to have been the case. I have reviewed this company a couple of times on the DSMR. Initially, I thought the management looked too keen to issue equity for a relatively minor acquisition when the shares were above £5, but the market didn’t share my concerns.

Then, when the trading update that started the share price fall was released, I commented that:

This is a mixed update. While the growth rates and operational gearing continue to be impressive, the numbers themselves appear to be slightly behind the consensus. Could this be the start of a trend for the company missing forecasts rather than exceeding them? Still, the 2025 EPS looks like it may be conservative, even if the revenue consensus isn’t.

I certainly didn’t foresee the concerns about a15% revenue growth rate causing such a sell-off. Most recently, when the results were announced at the end of April, the company said:

Excluding the contribution from Brand Architekts (from 12 February 2025), Group sales up 7% in Q1 2025 compared to Q1 2024

On the DSMR, Graham felt this may be a precursor to a profits warning. Given that the fall a couple of months ago was because the sales growth rate was 15%, which wasn’t enough to meet market expectations, I thought 7% sales growth would cause investors to run for the hills. Yet, the shares have rallied around 15% since. The uncomfortable truth is that the short-term share price direction in this type of stock is largely determined by investor sentiment rather than fundamental analysis, and the Momentum Ranks are much better at gauging this.

The more general case

An example, such as Warpaint London (LON:W7L) , can be highly educational, yet it remains a single data point. To see if we are on to something, we need many more examples. So what I have done is identify most of the companies that have been high flyers over the last year or so and found the point of their share price peak. Alex then provided the Stock Rank data for these for the year preceding their peak and up to a year after (the latest date I can get data for is now.) By identifying the peak share price and normalising the price data to that peak value, I have been able to gain further insight into the behaviour of High flyers around their share price peak. This is the graph of the average share price and stock Ranks in the run-up to the share price peaks:

As expected, the aggregation of over 40 share price and Stock Rank moves smooths out a lot of volatility. However, the story is pretty similar. The Quality and Value Ranks reflect the changes in fundamentals, but the changes are too small or gradual to give much signal. The Momentum Rank moves more rapidly. Most interestingly, despite over 40 stocks being aggregated here, there is a pronounced spike up in average share prices over a period of just a couple of weeks into the peak, which is quickly given back. Again, the divergence between the share price and Momentum Rank is the key indicator. However, on average, it is the share price spiking, but the Momentum Rank starting to fall gradually that is the point were investors may need to consider selling.

Weirdly, there is also a dip in Momentum Rank around 6 months prior to the ultimate share price peak. This may be just noise but I think it may alos be becasue share price spikes can often be casued by results and most companies report every six months. This reflects the impact of this reporting schedule on share prices. We have to be careful of false signals. Modest declines in the Momentum Rank shouldn’t cause investors to sell. However, a significant divergence between stock price and Momentum Rank over a period of a couple of weeks is likely a big warning sign.

Conclusion

Far from no one ringing a bell at the top of the market, the bing-bong indicating turbulence ahead for a High Flyer may be clearly heard. Roland was right when he surmised that investors need to pay attention to the changes in the Momentum Rank. It was just that his data wasn’t granular enough to pick this up. The key to using this knowledge is to spot when the Stock Price and Momentum Rank diverge significantly over a period of a couple of weeks. Sometimes, this will be the Momentum rank dropping precipitously, as it did with £W7L. However, it will usually take the form of a spike up in share price while the Momentum Rank drops modestly. Indeed, the latter case may be more useful, as it would mean investors are able to sell very close to the peak share price. Of course, with all Stock Rank strategies there will be counter-examples, where the share price and Momentum Rank diverged significantly but the shares went on to make new highs. However, on average, shareholders ignore the bing-bong at their peril.