Searching for Momentum - six stocks that are riding a wave
When it comes to investing strategies, the “buy low, sell high” mantra of value investors is the approach best known to those scrutinising the market for attractive potential returns. However, a closer look at the “buy high, sell higher” formula of momentum investing could result in even greater success – if you get your timing right. In the past 30 days the FTSE All Share has risen more than 6.5 percent – could that rise continue? And which stocks are riding the wave? We have highlighted six potential candidates for momentum investors.
The Trend is Your Friend
There are several ways of identifying momentum companies but the technique typically involves investing in those stocks that have performed best in the recent past – say 12 months. It can also mean selling or shorting the poorest performing stocks. Sounds simple? Read on.
Behind the momentum theory is the observation that stocks with form for strong performance tend to keep rising whereas poor performers will continue to lag. Although analysts are divided on why this happens, there is a sense that at least some of the reasons are behavioural. Advocates argue that investors in stocks that are at, or close, to their 52-week high are naturally slow to react to positive stock-related news. Likewise, investors will typically “jump in” to stocks that are rising (which serves to fuel that rise further).
Last year, the Credit Suisse Global Investment Returns Sourcebook, which is an authority on long-run global investment returns and investment styles, concluded that, since 1900, a momentum approach to buying stocks would have outperformed strategies that focus on size and value. It found that a strategy based on buying the previous year’s top-performing shares and then holding them for six months produced an annualised real return of 14.3 percent, against the market’s 9.5 per cent average.
But detractors of momentum investing claim that a strategy underpinned by picking past performers is too simplistic. In turn, few argue that the strategy demands constant market scrutiny and adept timing because it is susceptible to volatility and can unravel quickly in bear markets. In a 2010 white paper, Tom Hancock of investment firm GMO, put the point succinctly: “It is hard for the practitioners of a momentum strategy to launch a vigorous defense while looking foolish for having recently lost money with a portfolio of stocks bought simply on the basis of having recently gone up.”
Six Stocks Showing Momentum Right Now
Using Stockopedia Premium, we produced a list of the top 100 companies across all indices that are trading close to their 52 week highs and selected six potential candidates.
The two largest stocks in our list are drinks giants SABMiller (LON:SAB) and Diageo (LON:DGE), which are trading at 2.13% and 2.08% discount to their 52 week market highs respectively. Shares in both companies have doubled since spring 2009 and while market conditions for brewers operating in North America and Europe have been subdued, the excitement lies in emerging markets. In early January Diageo snapped up the Meta Abo Brewery in Ethiopia for US$225 million – an asset that SAB is also understood to have bid for.
In technology and telecoms, IT solutions business Advanced Computer Software (LON:ASW) makes it onto the list for trading at just 0.5% off its 52 week high. Shares in Advanced had been locked between 31p and 41p since May 2009 until a breakout last November triggered by positive half year results and upbeat growth projections. It wasn’t the only one – wireless specialist Anite (LON:AIE) endured an underwhelming share performance last year until the stock took off in November on the back of a strong first half performance. Its shares are currently 2.3% off their 52 week high.
Market mayhem last summer was unkind to industrials groups Fenner (LON:FENR) and Filtrona (LON:FLTR), particularly given the steady upward trends that both groups had displayed over the three previous years. For plastics specialist Filtrona, robust financial improvements and the US$110 million acquisition of Richco, announced in November, revitalised the shares, which are now just 2.5% off their 52 week high. Likewise, industrial belting business Fenner, saw profits soar last year and a small but significant acquisition in December drove up the share price even further, which is now just 2% off its 52 week high.
Think Different
You can analyse momentum strategies and stocks in depth as part of our upcoming Stockopedia Premium application (sign up now for early beta access!). As with all investing strategies, tracking momentum and using the 52 week high screen to do it should be just the start of the story. Regardless of company quality, traditional value investors would likely balk at the current share prices of our six-stock selection. Nevertheless, the weight of evidence supporting the momentum concept is worthy of consideration although so too are the risks of adopting the approach in volatile markets.
Disclaimer
This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
10 comments
Quoting from the same speech by Buffett:
"I always find it extraordinary that so many studies are made of price and volume behavior, the stuff of chartists. Can you imagine buying an entire business simply because the price of the business had been marked up substantially last week and the week before?"
Graham actually had a much stronger opinion. Quoting from The Intelligent Investor:
"Since our book is not addressed to speculators, it is not meant for those who trade in the market. Most of these people are guided by charts or other largely mechanical means of determining the right moments to buy and sell. The one principle that applies to nearly all these so-called “technical approaches” is that one should buy because a stock or the market has gone up and one should sell because it has declined. This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success on Wall Street. In our own stock-market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus “following the market.” We do not hesitate to declare that this approach is as fallacious as it is popular. "
Please note these comments are only to illustrate the opinion of some of the world's most respected investors on such approaches.
It is up to the reader to decide to whose opinions make more makes sense to him and which he should follow.
Hi Edward,
While it is very difficult to prove the validity of Graham's principles in shorter periods, Warren Buffett once gave a very compelling speech about why the large majority of successful investors are all Graham's students - http://www.anahin.net/superinvestors
Hi, actually I think the point of the Superinvestor speech was to rebut the Efficient Markets Hypothesis by pointing out the fact that Buffett knew of a large number of successful investors that could consistently outperform, who were all from the same "intellectual village", and therefore were unlikely to be the product of blind chance (as EMH implied). He wasn't commenting on whether there might or might not be other approaches that were also effective in beating the market.
Having said that, I am sure that Buffett would be highly sceptical of momentum investing in general given his underlying philosophy of investors having the priorities of a business owner focused on long-term value, rather than a stock trader focused on short-term gains and losses. But that doesn't mean it won't work - just that it's not his bag.
The empirical work actually suggests that value & momentum blend rather well together. Moskowitz and Grinblatt conclude that “A value-momentum combination mitigates the extreme negative return episodes a value investor will face (e.g., the tech boom of the late 1990s and early 2000 or a dismal year like 2008)”. Research also indicates that momentum can be a catalyst to value, i.e. the research suggests that value stocks that have been long-term losers but have high 6–12 month returns will go on to outperform by an even wider margin.
See also Lakonishok as an example of blending value and momentum:
http://www.stockopedia.com/content/josef-lakonishok-a-value-investing-momentum-screen-from-his-writings-58454/
Sorry, replied to the main article instead of your comment. Please see - http://www.stockopedia.com/content/searching-for-momentum-six-stocks-that-are-riding-a-wave-63376/?comment=6#6
The problem with any kind of technical approach is that falls in the market are always much more sudden and drastic than rises. Value investing and Graham's safety checks help prevent such sudden and drastic losses - http://www.anahin.net/principles
Statements like that are actually highly misleading anahin. While Graham's approach ought to encourage investors to invest with a good margin of safety there is no escaping market volatility and the risk of significant capital losses in the short term.
Historically value stocks have occasionally drastically underperformed the wider market - net nets and deep value stocks were literally thrown away in the financial crisis before rebounding very strongly in 2009 in the 'dash to trash' - they also suffered massively in the late 1990s. As mentioned in this article momentum strategies aren't immune to failing drastically either under certain market conditions - there really is no equity investment strategy that will always outperform in all market conditions.
Hi Edward,
You are right. The first statement was a little too general and misleading. Graham's principles can only help minimize losses in the short term, not eliminate them completely.
Thanks for pointing that out!
The intention was to convey that charting is dangerous and value investing is safer, but not that it was foolproof.
While it is very difficult to prove the validity of Graham's principles, especially in shorter periods, Warren Buffett once gave a very compelling speech about why the large majority of successful investors are all Graham's students - http://www.anahin.net/superinvestors
I still think that you are being misleading. While Graham's principles may minimize losses in the long termthere is nothing to suggest they will minimise them in the short term. Sure a good margin of safety will give you confidence in your position, but it's important to remember Graham's wise words that the market in the short term is a voting machine, whereas in the long term a weighing machine.
The way many fund managers minimise variance vs their benchmark in the short term is by joining the herd, which inevitably means a lot of trend following and momentum plays. As discussed this very regularly leads them off a cliff and damages long term performance !
Hi Edward,
A portfolio of stocks that is bought within the margin of safety usually falls a lot less than one that was already 4 times overpriced, even in the short term.
That's the idea behind the margin of safety - Graham's central principle; to minimize losses.
Here are some related quotes from The Intelligent Investor:
"However, the risk of paying too high a price for good-quality stocks—while a real one—is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions."
"The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. The determining trait of the enterprising (or active, or aggressive) investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average."
"Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY"
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
This was the basis of saying that Graham's principles help minimize losses (in general).
This was also the basis of the first statement that Graham's safety checks help prevent "such sudden and drastic losses" (as compared to charting, but not all losses), a statement that was not wrong in itself but could be misinterpreted and was hence elaborated on later.
if you still feel this is misleading, please accept an apology.
Please note these comments are only to illustrate the opinion of some of the world's most respected investors on such approaches.
It is up to the reader to decide to whose opinions make more makes sense to him and which he should follow.
Thank you for your time!
Amazingly enough there is quite a lot of academic research which suggests that there is a momentum effect. Exactly how you get it to work is another matter!
About 7 or 8 years ago I read the book 'trend following' and hated it, but the approach made sense and so I gave it a go. I found it too stressful and couldn't make any money with it, and more importantly I eventually decided I didn't like the premise behind it (that I'm effectively relying on the whims of other investors to generate my returns!).
I'm sure somebody more fleet of foot could do it, but I'm too slow and curmudgeonly to succeed with that kind of trading strategy. Slow and steady gets the job done and all that.