Stock Screen: Price Momentum + Fundamentals = Profits

Ultimately the performance of a stock will follow the underlying fundamentals of a firm. Stocks that are rising quickly usually represent firms which are executing well and have strong profit growth. On the other hand, stocks that are falling usually represent firms that are failing to grow earnings or whose fundamentals are declining.

Stocks which outperform the broad market have a few things in common:

• Strong earnings growth
• Affordable valuations
• Improving industry fundamentals
• A healthy balance sheets
• Sound management

Most investors target these qualities and hope their stocks will do better than most, but I would suggest also doing the reverse. Look for stocks outperforming because their outperformance more often than not is due to the traits above. Stocks with strong earnings growth, affordable valuations, and healthy balance sheets can outperform for years.

If you are a value investor you may find a firm with all off the above and at some point Wall Street will realize the fundamentals and reward the shares. But who knows when this will be. Finding shares where investors are already realizing the firm’s excellence can accelerate the process. This brings me to Relative Strength.

Relative Strength [RS] is an indexed based number which ranks how your stock is performing relative to the overall market over a given period of time. For example, if a stock has a relative strength of 80 it has outperformed 80% of the stocks over a specified period.

Combining RS with individual fundamentals can be an excellent beginning point for a stock screen.

The Screen

For this screen I took:

• 12-month return > 99% of all stocks
• QoQ EPS Growth > 0
• 5 Yr. Avg. ROE > 0

I received the following results:

click to enlarge

Clearly this screen produced stocks which have significantly outperformed the broader markets and it may represent an excellent starting point for further research. I will follow this post up in the next 30, 60, and 90 days with updates to see how they faired.

Disclosure: None

Comments

[billb:]

Simple, yet interesting. RS screens usually yields stocks that are "momentum" stocks. These could definitely outperform, but the volatility is usually a bit extreme. In other words, not for the faint of heart.

2008 Aug 26 07:51 AM

[Urbane Gori...:]

Contrast this method with the old 'Buy low P/E stocks'.... And you don't know where to turn.... What I'm trying to do lately is screen for stocks that have a steady uptrend over a period of months (I'm looking for nice clean steady movers..) and buy on the break back up through the MA20.

jegan ;-)

2008 Aug 26 01:13 PM

[Matt Blackman:]

Interesting analysis but Mark Barath misses one key point. Fundamentals lag price by at least three months and in some cases more, especially at key turning points. In other words, investors (or traders) who focus on the fundamentals and wait for them to give them an entry signal in the recovery or an exit signal in a slowdown will be severely punished.

Homebuilders are an excellent example. The following chart shows homebuilder stocks leading up to a peak in 2005 followed by a big breakdown. But as you see from the lower subgraph showing earnings growth, GPE (growth to PE) and EPS (earnings per share) did not show signs of real trouble until the price of the homebuilders index had been cut in half. (See Figure 5 tradesystemguru.com/co... ).

My research has consistently shown that while fundamentals provide useful confirmation in an uptrend (and weakening fundamentals confirmation of a bear market), price is the leading indicator and ignoring a price surge or breakdown while waiting for the fundamentals to tell you what to do can be an extremely costly practice.

2008 Aug 26 02:49 PM

[bigmoney:]

I like this approach. What stock screening tool is this?

2008 Aug 26 05:02 PM

[bigmoney:]

what stock screen tool is this?

2008 Aug 26 05:05 PM

[Capitalist Cow:]

It is a very large Excel spreadsheet.

2008 Aug 30 05:32 PM

[shostar:]

These are some good stocks especially Thoratec. No doubt about it.
Accelerated Revenue growth and a great balance sheet. Would be long on this all the way.

2008 Oct 20 06:26 PM