|
How to
Capitalize on Momentum
Despite their heavy use
by hedge fund managers and other pros, TV pundits and other market sages
generally only refer to momentum strategies in a negative context. For
example, “the momentum crowd has driven the stock of XYZ
Company up to outrageously overvalued levels.”
Although not for long-term investors, in my experience,
momentum strategies work well for shorter-term plays, say for hold periods
ranging from a few weeks to a few months.
With the market expected to remain strong
until year-end, this may be a good time to consider a momentum strategy.
While the strategies vary in detail, all
include three basic requirements. Qualifying stocks must have already
moved up in price, they must have recorded strong historical earnings
growth, and analysts must be forecasting accelerating future growth.
Screening is a process for scanning the
market for stocks meeting your specific requirements. Here’s a screen for
finding momentum stocks. It uses a powerful screening program provided by
a new financial site, FINVIZ.com. The program is easy to use and it’s
free.
Find it from the FINVIZ homepage (finviz.com)
by selecting
Screener. FINVIZ calls its selection parameters “filters.” On the
Filters bar, select “All” so that you can see all of the available filters
at the same time. Use the associated dropdown menus to select the desired
filter values. Here’s how to set up my momentum screen.
In-Favor
Momentum candidates should be in favor with most market players. We can
measure that by checking analyst ratings. Stock analysts publish
buy/hold/sell ratings on the stocks that they cover. FINVIZ compiles the
ratings into strong buy, buy, hold, sell, and strong sell categories.
Isolate “in favor” stocks by requiring “buy or better” analyst
recommendations.
Big Money
Institutional investors such as mutual funds and pension plans account for
most stock ownership. Institutional ownership measures the percentage of a
firm’s shares held by these big players. For in favor stocks,
institutional ownership typically ranges from 40% to 95%. Specify “Over
40%” for Institutional Ownership.
Profitable?
Momentum investing requires picking profitable companies. Profitability
gauge “return on assets” compares net income to total assets. Any positive
value signals a profitable company, but in terms of profitability, the
higher the better. Specify a “Over 10%” for return on assets to limit your
results to the most profitable stocks.
Strong Chart
Momentum candidates must be in uptrends, meaning that their share prices
are steadily moving higher (Stocks moving lower are in downtrends).
You can compare the current share price to
its moving average (average closing price over a specified period) to
determine a stock’s trend. Stocks trading above their moving averages are
said to be in uptrends. How far a stock is trading above its moving
average determines the trend strength.
FINVIZ provides a choice of 20-, 50-, or
200-day moving averages. Use the 200-day MA (Simple Moving Average) and
select the “Price 20% above” option, which requires passing stocks to be
trading at least 20% above their 200-day MAs, signaling a strong uptrend.
Low Debt
Stocks carrying high-debt are riskier than low-debt stocks. The long-term
debt/equity ratio compares long-term debt to shareholders equity (book
value). Zero values signal no debt, and the higher the ratio, the higher
the debt. Specify “under 0.1” LT Debt/Equity to allow companies listing
incidental debt such as long-term leases on their balance sheets.
Earnings Growth
Momentum candidates must be growing earnings at least 15% annually, and
that growth rate should be accelerating. Require “over 15%” growth for
this year (EPS Growth This Year) and “over 25%” for analysts forecast EPS
(earnings per share) growth for next year.
My screen turned up five momentum candidates:
biopharma drug developer Alexion Pharmaceuticals, physician business
service provider Athena Health, Chinese language Internet search engine
operator Baidu, Chinese adult educator New Oriental Education and
Technology, and database software provider Netezza.
As is the case for all screens, consider the
results as research candidates, not a buy list.
Momentum strategies work best in strong markets. Also, momentum
picks are not long-term holds.
They can go down as fast as they've gone up.
Sell on any bad news.
published
9/13/09 |
