How To Find Breakout Stocks With Positive Price Momentum

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Includes: AGXKF, BPRMF, BSHVF, CLLLF, FBDTF, GMWKF, HKMPF, INFCF, IQEPF, OCDGF, OXBDF, PSO, QNTQF, RGPMF
by: Stockopedia
Summary

For a good chunk of 2018, the UK's equity markets were under the cosh, and index prices fell across the board.

In investing, momentum is the tendency for price trends to persist.

Pure price momentum, combined with no other factors, can highlight popular story stocks that can be very speculative.

For a good chunk of 2018, the UK's equity markets were under the cosh, and index prices fell across the board. But, since the start of this year, there's been a sense of optimism around. Political and economic uncertainties aside, the FTSE All-Share has managed a 6.8 percent gain in recent weeks. It's a modest result, but one I reckon most investors are happy to take.

That said, 6.8 percent is just the index, or average, gain. Lift the lid and you'll find that some stocks have done far, far better than that (and others, of course, far worse). What's interesting, according to research, is that stocks with the strongest outperformance have a statistically strong chance of maintaining that trend. This is the power of one of the most powerful 'factors', or return drivers in the stock market: momentum.

Digging into momentum

In investing, momentum is the tendency for price trends to persist. It causes securities with rising prices to rise further, and securities with falling prices to fall further. It sits alongside other factors like 'value' and 'quality' as a cornerstone of some of the most influential strategies around.

Over the past 30 years, some of the smartest minds in finance have studied why momentum works and how it can be captured.

Some believe that, just like value investing, there's a risk premium attached to momentum. In other words, its profits only exist because there are times when the strategy doesn't work. It's known that momentum can crash periodically. In years like 2018, when a lot of fast-growing momentum stocks were pegged back, momentum strategies really suffer. As Wes Gray, the boss of US quant fund firm Alpha Architect said to me last year, "when you look at real momentum strategies done the way that gives you those historical premiums, those portfolios are hair-raising."

Another much more accepted view of momentum is that it's caused by investor behaviour and their underreaction and delayed overreaction to news. With underreaction, prices are slow to react because investors are either cautious, not looking, or can't trade. But with delayed overreaction, investors chasing rising prices attract the attention of the investing herd, who follow them into those trades, pushing prices higher and higher.

Chasing price momentum

One of the original "pure" momentum strategies was one developed by the researchers Narasimhan Jegadeesh and Sheridan Titman. Their work looked solely at a stock's price strength relative to the rest of the market. They found that momentum often lagged for the first month but then accelerated over the subsequent six to 12 months.

They wrote:

"The strategy we examine in most detail, which selects stocks based on their past 6-month returns and holds them for 6 months, realises a compounded excess return of 12.01% per year on average."

This is a strategy that we track here at Stockopedia, and it has proved to be pretty resilient over the past six years. But, in the chart below, you can also see how the kinds of conditions we saw in 2018 cause momentum to pull back very sharply. You can find the screen here.

Even so, over the past two years, this strategy of just buying the strongest momentum stocks has resulted in a pre-costs return of 37 percent (when the portfolio was refreshed quarterly) and 12 percent over the past year.

So, what are the stocks currently passing these momentum tests? Of the top 30 companies across the market, here are the top 5 sorted by the strongest relative price strength over the past year:

Name

Mkt Cap £m

Relative Strength 1y

Relative Strength 6m

Relative Strength 1m

Sector

Bushveld Minerals (OTC:BSHVF)

411.3

+341.7

+50.1

-10.5

Energy

Anglo Asian Mining (OTCPK:AGXKF)

100.1

+140.8

+132.6

-1.51

Basic Materials

Regal Petroleum (OTCPK:RGPMF)

160.3

+120.6

+50.7

-18.0

Energy

Forbidden Technologies (OTC:FBDTF)

22.9

+116.1

+52.6

-7.38

Technology

Elektron Technology

81.9

+116

+16.9

-2.08

Industrials

As you can see, the stocks tend to be small and more speculative, but they've all see very strong relative price strength over the year.

But if you re-sort that top 30 list and focus on the largest price momentum stocks, the top 5 look like this:

Name

Mkt Cap £m

Relative Strength 1y

Relative Strength 6m

Relative Strength 1m

Sector

Pearson (NYSE:PSO)

7,261

+40.4

+11.3

-6.60

Consumer Cyclicals

Hikma Pharmaceuticals (OTCPK:HKMPF)

3,948

+81.5

+9.30

-5.00

Healthcare

3I Infrastructure (OTC:INFCF)

2,160

+38.6

+23.4

-0.55

Financials

Qinetiq (OTCPK:QNTQF)

1,702

+53.4

+21.9

-0.55

Industrials

Games Workshop (OTCPK:GMWKF)

950.6

+34.7

+3.40

-8.66

Consumer Cyclicals

Here we've got companies like Pearson, Hikma, and Qinetiq, which have very much been stocks in recovery over the past year. They mix it up with companies like 3i Infrastructure, which resisted the market slide altogether, and Games Workshop, which surged early in 2018 and didn't fall as hard when the market slumped later on.

Last year, this Price Momentum strategy picked up some big winners including stocks like Ocado (OTCPK:OCDGF), Games Workshop, Plus 500, Blue Prism (OTCPK:BPRMF), and Oxford Biomedica (OTCPK:OXBDF). But, at times, it also held stocks that went on to seriously underperform, like IQE (OTCPK:IQEPF), Yu and Cloudcall (OTC:CLLLF).

So, while momentum strategies are designed to select the strongest performing stocks in the market, they're not infallible. Pure price momentum, combined with no other factors, can highlight popular story stocks that can be very speculative. They may well do well, but serious care is needed. But the strategy can also highlight larger stocks bouncing back from difficult times or those more resilient to depressed conditions. For some, at least, the evidence suggests that stocks with this kind of profile will often continue to outperform.

So, while it can be scarily volatile, momentum is well-recognised as a powerful driver of market returns. It can be a handy pointer to the market's strongest performing stocks, and it has a performance track record that's hard to ignore.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.