10 cheap FTSE 350 shares with momentum

Mixed signals about the economic outlook made markets volatile in early 2023, but renewed optimism is moving some large-caps higher. Here’s how you can identify the early winners.

After an upbeat start to 2023, the FTSE 350 index of Britain’s largest quoted shares slumped in early March. It was a reminder that the turmoil of 2022 isn’t quite behind us yet.

There was always a risk of unforeseen consequences from the quick succession of interest rate hikes doled out by central banks over the past year or so.

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It turned out that regional US banks - in the form of Silicon Valley Bank and Signature Bank - were among the first to break. Panic about a possible banking crisis was quickly contained, although there is still concern about credit availability for US firms further down the line. But for the time being at least, the fear has been dialled down.

And with it, the FTSE 350 is breaking out again. Over the past four weeks, the combined index of large-cap and mid-cap shares has risen by 7.3% (see the chart below). It suggests that, bar the occasional panic, the market is relaxed about the prospect of any severe recession, and perhaps even sees a cut in rates on the distant horizon.

Source: interactive investor

So how should investors interpret this apparent shift in sentiment?

With news this week that UK inflation remains frustratingly sticky, at over 10%, it’s likely that firms will remain focused on passing on rising costs where they can in order to protect profits. Another interest rate rise also seems likely before cuts eventually take over.

One strategy in these circumstances is to combine two of the most influential ‘factors’ that are known to drive returns in the stock market: value and momentum.

How to find cheap shares on the move

Value and momentum are the core principles used by many successful investors and traders, and they continue to be popular today.

After a volatile year, most of us will be looking for reasonable valuations before buying into the market. There are various ways of looking for value, but finding stocks trading on price-to-earnings (PE) ratios that are below their five-year average is an easy-to-understand place to start. Are they cheaper than usual? From there you can dig as far into the valuations as you like.

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Next is to consider momentum in both earnings and price. With earnings, at the very least you will want to see firms that have managed to deliver profit growth in the previous year, and are forecast to grow their earnings again in the year ahead. This kind of momentum is a core tenet of the “previous winners tend to keep winning” approach used by growth investors and traders.

When it comes to share price momentum, the academic research is clear: it tends to be a powerful but medium-term phenomenon. Shares that outperform the index do so for around a year before the momentum ebbs away, or new news pushes them higher. For recent moves, look for strong momentum over six and three months.

Here are some of the stocks that these rules pick up:

Source: SharePad

As a reminder, all these shares trade on PE ratios that are lower than their five-year averages. In some cases the difference is slim: at 17.5x, Moneysupermarket.com (LSE:MONY) is only fractionally below its average. But in others there is a wider gap: for example, WPP (LSE:WPP)has a current PE of 9.8x versus an average of 12.1x. Note that there are competing influences on PE ratios, but this approach gives you somewhere to start.

On earnings, all of the shares had to show profit growth both last year and in forecasts for the year ahead. In most cases, earnings per share (EPS) growth last year was well into double-digits, with Pets at Home (LSE:PETS), Informa (LSE:INF) and Weir Group (LSE:WEIR) all seeing strong growth rates.

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To make it on to this list, each share needed to have a six-month relative price strength of at least 10%, and the list is then sorted based on price strength over three months. That aims to find the strongest near-term momentum. On that basis, Moneysupermarket and Pets at Home lead overall.

It’s worth noting that short-term price momentum can be quite a noisy measure. The longer, six-month momentum for these shares is strong across the list, which tells you that they have performed well in the market since at least last autumn.

It’s also worth mentioning that the list contains six FTSE 250 shares and four FTSE 100 shares. While the two indices do move differently (the FTSE 250 really struggled last year), it’s possible to find potentially interesting value and momentum shares in both of them.

Momentum as an early signal of optimism

Momentum strategies had a difficult time in 2022 because markets were under pressure and the economic outlook was even more uncertain than usual. While investors continue to wrestle with what the future might hold, momentum can be a useful early indicator that shares are starting to pick up.

We’ve seen signs in the first few months of 2023 that the market is looking ahead, and some stocks are delivering expectation-beating results. If this optimism continues, a value-momentum approach could be a useful way of picking up the early winners.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.