10 stocks passing all the price momentum tests

Stockpedia's investment analyst reveals the shares which make this most straightforward momentum strategy.

For a good chunk of 2018, UK equity markets were under the cosh. Index prices were sliding across the board right up until the final few days of the year. But this month there's been a sense of optimism in the air. In spite of all the political and economic questions playing on investors' minds, the FTSE All Share has managed a 3.6% gain in January. It's a modest result, but I'm pretty sure most investors will happily take it.

Of course, 3.6% is just the index, or average gain. Lift the lid and you actually find that some stocks have done much better than that. What's more, the fact that these shares have got strong momentum behind them means that they are statistically likely to keep outperforming over the medium term. Such is the power of one of the most powerful 'factors', or return-drivers in the stock market.

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. Momentum 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.

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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 well known that momentum can crash periodically. And in years like 2018, when a lot of fast-growing momentum stocks were pegged back, momentum strategies suffer. So investors are wary of it, and they demand a premium from it as a result.

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 most straightforward momentum strategies is 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. 

Source: Stockopedia   Past performance is not a guide to future performance

A version of this strategy tracked by Stockopedia has proved to be resilient over the past six years. But you can see how the kinds of conditions we saw in 2018 cause momentum to pull back very sharply. Even so, over the past two years alone, this strategy of just buying the strongest momentum stocks has resulted in a pre-costs return of 38.9% (when the portfolio was refreshed quarterly).

So what are the stocks currently passing these momentum tests? Of the top 30 companies across the market, here are the top 10 largest by market cap:

Source: Stockopedia   Past performance is not a guide to future performance

There is a broad mix of industry sectors on this list, with cyclical stocks like education group Pearson (LSE:PSON) and PR firm Huntsworth (LSE:HNT) mixing it up with the likes of mining groups EVRAZ (LSE:EVR) and SolGold (LSE:SOLG), pharma company Hikma (LSE:HIK), comms group Telecom Plus (LSE:TEP) and specialist materials firm Zotefoams (LSE:ZTF).

What these stocks share in common is that they've beaten the market over the past six and 12 months. In each case, they've managed to resist the market trend, and evidence suggests that stocks with this kind of profile will often continue to outperform. 

But it's important to do your own research. There are no guarantees and momentum strategies are prone to reversals when market sentiment changes. For that reason, it can be worth blending momentum with other factors like value and quality. 

That said, momentum is now 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.

About Stockopedia

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