The stock market's sustained bull run is a reminder that momentum as an investing strategy can work well.
ion that they will continue to do so is more akin to banking on the emotional and irrational reactions of performance chasers by systematically identifying and buying shares that are on the rise. Momentum investors, while gravitating toward well-performing stocks, are doing so in; (1) a rule-based manner with entry and exit plans in place, and (2) with a view toward the short- and intermediate- term, rather than the long-term view of value investors.
At Validea, we run a stock screening model that combines a momentum approach (both at the stock and industry level) with a series of fundamental factors. The portfolio has returned 423 percent over the last fifteen years, outperforming the S&P 500 for 9 of them, and was our top performer in 2017 with a return of 57.2 percent (nearly triple the S&P 500's 19.4 percent gain).
- Earnings-per-share consistency and growth
- Share price performance and relative strength
- Shares outstanding
- Insider ownership
- Industry appeal
Earnings-per-share represents an integral part of a momentum strategy, which looks for persistent year-over-year growth and both quarter-over-quarter and annual growth to be a minimum of 18%.
Share Price-is preferred to fall within 15% of the 52-week high, as this would indicate that the stock is potentially close to reaching a new high if trading volume were to climb to above-average levels. Relative strength (price performance compared with overall market) over the past year should be no less than 80, but preferably 90. This is a good indicator as it can keep investors from buying stocks that are on the decline.
Leverage: This strategy prefers companies that have consistently reduced debt over the last 3 years or have debt-equity ratios of less than 2 (this criterion does not apply to financial firms).
Shares outstanding of under 30 million is preferable, as fewer shares leads to bigger price jumps when demand surges.
Insider ownership of at least 15% is preferred under this strategy because where there is strong insider ownership, management is more likely to act in the best interest of the company.
Industry appeal is considered adequate if at least one other company has a relative strength of above 80.
Like most investment strategies, the momentum approach doesn't work all the time and has its own set of challenges. If not executed well, it's high-turnover structure can end up being costly or lead to tax inefficiencies. The strategy can also be tricky since it attempts to benefit from the irrational behavior of other investors which, by its very nature, can also reverse quickly and leave a momentum investor holding the bag (to avoid this, many investors use stops, or automatic sells that are triggered if a stock falls by a certain percentage). But an investor can identify momentum stocks that are built on a solid foundation by combining a momentum factor with other fundamental criteria.
Using my momentum-focused stock screening model, I have identified the following four high-scoring stocks:
|Company ||Ticker ||Market Cap ($ billion) ||Price/Earnings ||Relative Strength |
|Arista Networks Inc. ||ANET ||19.0 ||54.2 ||95 |
|Thor Industries ||THO ||5.1 ||18.1 ||90 |
|Netease Inc. (ADR) ||NTES ||43.2 ||21.5 ||76 |
|Toll Brothers Inc. ||TOL ||8.1 ||16.3 ||88 |
Arista Networks Inc. ( ANET ) is a supplier of cloud networking solutions that use software innovations to address the needs of Internet companies, cloud service providers and data centers for enterprise support. The company scores highly according to our momentum investment strategy based on the consistency and growth in EPS as well as its current share price level of $260.79, which is well within 15% of its 52-week high ($261.81). Return-on-equity of 29.7% is nearly double the required minimum level of 17% required by this model, and insider share ownership of 25% exceeds the required minimum of 15%.
Thor Industries, Inc. ( THO ) manufactures a range of recreational vehicles (RVs) in the United States and sells those vehicles primarily in the U.S. and Canada. Strong quarterly EPS growth (63%) is well above the minimum 18% that this methodology favors. The company also boasts a debt-equity ratio of .05, which adds appeal (the screen allows a maximum of 2.0) as does return-on-equity of 28.2%.
NetEase, Inc. ( NTES ) is a technology company that operates an interactive online community in China and is a provider of Chinese language content and services through its online games, Internet media, e-mail, e-commerce and other businesses. Both quarterly and annual EPS consistency and growth earn the company high scores, as does return-on-equity of 32.8% and a debt-free balance sheet.
Toll Brothers, Inc. ( TOL ) is engaged in designing, building, marketing, selling and arranging financing for detached and attached homes in luxury residential communities. The company scores well based on the trend in recent quarterly earnings, which have shown growth that outpaces the company's typical increase.
At the time of publication, John Reese and/or his private clients were long ANET, THO, NTES and TOL