When To Sell Adventurous Growth (QM) Stocks

21st Jun '23 by Mark Simpson

7 comments 2494 reads

This week, Megan has been looking at Adventurous Growth strategies, which are stocks on the Stockopedia Style Map that are high quality and have high momentum:

We know that the Quality and Momentum Rank are positively correlated due to the inclusion of measures of earnings momentum in both measures:

However, in many ways, they are very different strategies. Quality strategies require patience as better companies compound their re-invested capital. Whereas, Momentum is short-lived and requires regular rebalancing into recent winners, as this chart from one of my favourite studies (Factors from Scratch) shows:

So, the big question is when should an investor sell a QM stock? Should they sell quickly as momentum fades, or can they hold for the long term and minimise trading costs and other frictions? I set about trying to find the answer with some data.

Methodology

Starting with the 30 highest-ranked QM stocks at the end of each year, 2014-2021, I looked at how these stocks performed over the subsequent time periods. For example, these are the 30 highest QM-Ranked stocks on 30 December 2014:

Character (LON:CCT) Zytronic (LON:ZYT) 4imprint (LON:FOUR) Jet2 (LON:JET2) Atlantic Lithium (LON:ALL) Advanced Medical Solutions (LON:AMS) Avon Protection (LON:AVON) James Latham (LON:LTHM) Animalcare (LON:ANCR) City of London Investment (LON:CLIG) £RM Benchmark Holdings (LON:BMK) Idox (LON:IDOX) Portmeirion (LON:PMP) FD Technologies (LON:FDP) Solid State (LON:SOLI) Hill & Smith (LON:HILS) FDM (Holdings) (LON:FDM) K3 Business Technology (LON:KBT) CVS (LON:CVSG) Safestyle UK (LON:SFE) Costain (LON:COST) Gooch & Housego (LON:GHH) Mattioli Woods (LON:MTW) Liontrust Asset Management (LON:LIO) Churchill China (LON:CHH) CML Microsystems (LON:CML) YouGov (LON:YOU) Tracsis (LON:TRCS) Impellam (LON:IPEL)

Since the Stockopedia data began in 2014, I couldn’t go any further back, but it means we have one 8-yr period, two 7-yr periods, …., and eight 1-yr periods of performance to study. I then looked at the average cumulative outperformance of these sets of 30 QM stocks based on prices from Google Finance.

Results

Here is the key finding:

…

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DWit199

21st Jun '23

Starting with the 30 highest-ranked QM stocks at the end of each year, 2014-2021, I looked at how these stocks performed over the subsequent time periods

How did you get these year end QM ranks?

Mark Simpson

Ed ran a database query for me! Sorry, don’t think there is a generally available way to do it on the public site.

Bob Cratchit

Very useful. Thanks, Mark.

You said about the strategy: "I would only follow it when market indices have clear trends." And that raises the intriguing possibility of switching between strategies according to market conditions -- rather than just waiting for a particular style to begin working again.

Is there any mileage in the idea of Stockopedia discussing in an article what strategies may be optimum for various market and economic conditions?

In the meantime, what strategy would you favour right now and why?

googlyeyes

Thanks Mark but on the point of "After six months, I would review the portfolio and sell all the stocks if the portfolio hadn't outperformed the market. Otherwise, I would hold for a further six to twelve months before selling and forming a new high QM portfolio" - there is a risk of throwing the baby out with the bath water...would it not be best to evaluate each of the stocks in the portfolio and remove the weeds (and keep the flowers so to speak). I would agree with the point about market conditions being in your favour/trending (and I assume the momentum ranking has some basis on Relative strength which can be high even in a declining stock if the wider market is falling faster)

22nd Jun '23

The interesting thing is that pretty much every factor strategy, Small, Q, V & M has struggled this year, making it a pretty unique investing time.

That could be an interesting article. Although perhaps a difficult one to research definitively.

In terms of investing now, UK vs the US and small and mid-caps vs large caps would seem to be the place to be, given the valuation differentials across these markets and sizes. This doesn't mean that these will immediately outperform, but with a 2-yr investing horizon, the odds are stacked in favour of UK small caps. Part of the reason is the scale of outflows recently, which are a contrarian indicator of high future returns. See https://www.stockopedia.com/co...

Momentum looks risky at the moment, certainly in UK stocks. See here: https://www.stockopedia.com/co...

However, this may just be wishful thinking as a mainly UK small cap value investor.

If you can come up with a consistent way of doing this, then that would be great. But it can be quite hard to tell the weeds from the flowers. For example, here is the performance of the underperforming End of 2021 QM portfolio after six months, plotted against the subsequent almost 1-year performance:

So the relationship is slightly positive but weak. And if you only held the winners from the first six months and sold the rest, you would be left with seven stocks, of which only three were subsequent winners. So not necessarily a great return. You'd need a lot more data to draw conclusions at the stock level rather portfolio level given the extra noise.

I don't think this is strictly true. The main factor that has failed is the small cap effect. If you use a capitalisation weighted index as your benchmark you may come to the conclusion that factors have all failed, but by comparing to the average share, quality, value, momentum and volatility have all been effective.

See this post Here

When to sell adventurous growth (QM) stocks

Methodology

Results

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Mark Simpson

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