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How to
Capitalize on Momentum
With the U.S. economy in recovery mode it’s time to consider momentum
stock picking strategies. These strategies focus on finding relatively
small stocks with fast growing earnings and that have already outperformed
the overall market. Although heavily used by hedge funds, momentum
strategies aren’t used much by individual investors.
Here’s how you can use Zacks Investment Research’s Custom Stock Screener
to find momentum candidates. If you’re not familiar with the term, stock
screeners are web-based tools that allow you to search the entire market
for stocks meeting your selection requirements. Zacks’ provides the only
free screener I know of that is capable of finding momentum candidates.
Find it by selecting “Screening” from Zacks homepage (www.zacks.com)
and then
Custom Stock Screener (Stock & Fund Screening Tools). Once there,
click on a Category name to see the available search choices for that
group. Start with Market-Cap, which is listed in the Size & Share Volume
category.
Smaller Is Better
Market capitalization measures company size. It’s how much you’d have to
pay to buy all of a company’s shares. Market-caps above $10 billion define
large-cap stocks, while stocks with market-caps below $2 billion are
termed small-caps. Those between $2 billion and $10 billion are mid-caps.
As mentioned earlier, smaller companies usually do best in strong markets.
However, because smaller stocks are usually riskier than larger stocks,
it’s best to avoid stocks with market-caps below $250 million. So, specify
a minimum $250 million market-cap (market-cap >= 250), and click “Add” to
add that requirement to your screen (“>=” translates to greater than or
equal and “<=” means less than or equal). Zacks displays your selected
search criteria near the top and indicates how many stocks meet your
screen’s requirements.
Outperforming?
Momentum strategies require stocks that are already outperforming the
market. Zacks’ Relative Price Change parameter (Price & Price Changes
category) compares a stock’s year-to-date price performance to the overall
market. Values above one tells you that the stock has outperformed the
market and values below one signal an underperforming stock. Specify
Relative Price Change >= 1.15 which requires that passing stocks must have
outperformed the market by at least 15 percent so far this year.
Analyst Advice
Stock analysts publish buy/sell recommendations on the stocks that they
follow. Zacks compiles the analysts’ advice into “strong buy” (1), “buy”
(2), “hold” (3), “sell” (4), and “strong sell” (5) categories, and assigns
a consensus value based on the numbers shown in parenthesis. For instance,
if two analysts are following a stock and one rates it buy and the other
is at hold; the consensus rating would be 2.
The best momentum candidates are in-favor with analysts, so specify
“Current Average Broker Recommendation <=2, which requires consensus
ratings of buy or better (Recommendation Broker Rating category).
Got Growth?
Analysts also publish estimates for long-term (three to five years)
average annual earnings growth. Momentum candidates must have strong
earnings growth expectations. Specify minimum 15 percent expected earnings
growth (Long-Term Growth Consensus Estimate >= 15) in the EPS Growth
category.
Profitable?
Momentum candidates must also be profitable. Return on equity (income vs.
book value) is a popular profitability measure. For profitable companies,
values typically range from five percent to 25 percent, where higher is
better. Most professional money managers require at least 15 percent ROE,
so specify Current ROE >= 15 (Return on Investment).
Low Debt
The best momentum candidates have little or no debt. The debt/equity
ratio, which compares long-term debt to book value, is a good debt
measure. A zero D/E signals no debt, and the higher the ratio the higher
the debt. Specify “Debt/Equity Ratio <= 0.1” (Liquidity & Coverage).
Earnings Forecasts
Momentum strategies require stocks with positive momentum in terms of
analyst’s earnings forecasts. That means that current consensus forecasts
must be higher than they were a few weeks ago.
Zacks’ “% Change F1 Estimate (4 weeks)” parameter (EPS Estimate Revisions)
tracks the last four-weeks percentage change in current year consensus
earnings forecasts. Require a minimum five percent increase (>= 5).
Surprise
An earnings surprise is the difference between analyst forecasts and
actual reported earnings. It’s a positive surprise when earnings beat
forecasts and a negative surprise when they fall short. Momentum
strategies require recent positive surprises. Require a minimum 10 percent
recent surprise (Last EPS Surprise % >= 10) in the EPS Surprises Category.
My screen, which I ran the day before the
earthquake in Japan and the resulting tsunami, turned up five stocks:
• Atmel (ATML)
• Deckers Outdoor (DECK),
• Diodes (DIOD)
• JinkoSolar (JKS),
• Netease (NTES).
Momentum investing requires an uptrending market. So, be ready to bail out
when the market takes a dive. Further, consider stocks turned up by any
screen to be research candidates, not a buy list. The more you know about
your stocks, the better your results.
3/13/11 |
