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Monstrous three-fold momentum returns

Over the past seven years my Monsters of Momentum screen has delivered a threefold total return, substantially outperforming the market – and 13 more stocks are ready to roar
November 14, 2017

My Monsters of Momentum screen is one of the longest running strategies followed by this column and, with dividends reinvested, it now boast a threefold return over the seven years I’ve monitored it.

The idea behind the screen is simply to target shares that are on a tear of eye-popping magnitude. While this was devised as something of a gung-ho, red-blooded screen, the approach does chime with some loftier ideas promoted by prominent market thinkers. Notably, a recent study by Research Affiliates has highlighted the “perils of stale momentum” and attractions of fresh momentum based on a study of US stocks from February 1928 to June 2016.

From a portfolio of stocks showing strong 12-month momentum, the investment firm looked for “stale momentum” by selecting the fifth of stocks that had exhibited the strongest gains in the year preceding the 12 months used for selection. On average, these stale momentum stocks performed considerably worse than the momentum portfolio as a whole. What’s more, the fifth of stocks that showed fresh momentum, based on the weakness of their prior-period performance, did much better than the rest. Indeed, the cumulative performance of Research Affiliates' stale momentum stocks peaked at just over 1 per cent by month five, whereas fresh momentum peaked at 7 per cent by month 11 – in other words, fresh momentum has historically tended to be stronger and to last longer.

A key lesson that can potentially be drawn from these findings would seem to be that, like most other things in investment, momentum does not last forever, and the longer it has persisted the more likely it is to 'revert to mean'.

Anyone hunting for momentum stocks should heed the warning that popular investment cases do get stale, causing momentum to wane quickly, but some of the best momentum stocks do in fact shoot the lights out persistently for several years. The Monsters of Momentum screen attempts to target momentum that is still fresh using a rather different approach than simply filtering out those shares that have been rising for a suspiciously long time. Instead, it focuses on selecting stocks that fit a criteria that suggests they are still red hot!

The full screen criteria are as follows:

■ Price momentum: A share price rise in the top 10 per cent of shares screened over the past three months, in the top 25 per cent over six months, and in the top 50 per cent over a year.

■ Trend: The 10-day moving average must be above the 30-day, which in turn must be above the 100-day.

■ Earnings growth: Average forecast earnings growth for the next two financial years must be among the top quarter of all stocks screened.

■ Volume: Average daily volumes over the past three months must be above the level from a year ago.

This strategy worked well last year, producing a 32.8 per cent total return compared with 14.3 per cent from the FTSE All-Share. The screen has actually only underperformed the market in one of the past seven years (see tables below). Despite such persistent outperformance against the market, and a surprisingly low beta (an indicator of the sensitivity of returns to the wider market) against the FTSE All-Share of 0.3, I would nevertheless regard this performance-chasing screen as a high-risk approach. In particular, I think there are reasons to worry about what could happen to this screen in a bear market, and it will be interesting to see what occurs when that happens – whenever that may be.

 

2016 performance

NameTIDMTotal Return (9 Nov 2016 - 8 Nov 2017)
FerrexpoFXPO164%
NMC HealthcareNMC129%
SanneSNN57%
Standard Life Private EquitySEP34%
Fidelity China Special SitsFCSS33%
TrifastTRI28%
Entertainment OneETO26%
HSBCHSBA25%
Pantheon InternationalPIN17%
IndiviorINDV7%
Riverstone EnergyRSE5%
WM MorrisonMORW1%
TescoTSCO-11%
Petra DiamondsPDL-54%
FTSE All Share-14%
Monsters of Momentum-33%

 

Year by year

Year to Nov/OctFTSE All ShareMonstersFTSE All ShareMonstersMonsters with 1.5% charge
2010--£10,000£10,000£10,000
2011-2.9%4.1%£9,710£10,410£10,254
201210.5%18.5%£10,730£12,336£11,969
201322.4%44.3%£13,133£17,801£17,012
2014-1.1%12.8%£12,989£20,079£18,901
20154.3%30.1%£13,547£26,123£24,222
201612.8%-12.9%£15,281£22,753£20,781
201714.3%32.8%£17,466£30,216£27,183

Source: Thomson Datastream

 

The cumulative total return from the screen over seven years now stands at 202 per cent – a threefold return – compared with 74.7 per cent from the FTSE All-Share over the same period. If I factor in a notional annual charge of 1.5 per cent to account for the costs of switching from one portfolio of stocks to another each time new screen results are published, the total return drops to 172 per cent.

 

As with past years, very few FTSE All-Share stocks passed all the screen’s tests. I’ve therefore also looked at stocks that met a weakened criteria based on passing the price momentum and moving-average tests, but which fell short on either the test for trading volume growth or forecast EPS growth. Based on the weakened criteria, 13 shares have qualified as Monsters of Momentum, with only one of these meeting all the screen’s criteria. To give a flavour of this year’s Monsters I’ve provided a write-up of the only share that passed all the criteria, NMC, along with the share showing the strongest three-month momentum that qualified on the weakened criteria, Games Workshop. The table is ordered from strongest to weakest three-month momentum.

 

Here be monsters

NameTIDMSectorMkt CapPriceFwd NTM PEDYPEGFwd EPS Grth FY+1Fwd EPS Grth FY+23-mth Momentum6-mth Momentum1-yr MomentumNet Cash/Debt(-)CurTest Failed
NMC HealthNMCHealthcare£6.5bn3,199p360.3%1.536%29%41%51%125%-$1.1bnUSDNone
Games WorkshopGAWConsumer Discretionary£699m2,174p134.6%1.171%-18%35%124%286%£18mGBPEPS Grth
Just EatJE.Information Technology£5.5bn813p41-1.938%30%33%46%47%£177mGBPVolume
XP PowerXPPIndustrials£679m3,566p242.0%2.323%4.4%33%36%106%£8mGBPEPS Grth
SophosSOPHInformation Technology£2.9bn615p920.6%--2.8%38%33%90%178%$81mUSDEPS Grth
AVEVAAVVInformation Technology£1.6bn2,560p351.6%5.68.0%6.8%32%29%46%£131mGBPEPS Grth
PureCirclePUREConsumer Staples£862m495p114-8.0-19%70%24%51%93%-$84mUSDEPS Grth
SuperGroupSGPConsumer Discretionary£1.5bn1,858p201.5%1.613%13%19%18%29%£68mGBPEPS Grth
RenishawRSWInformation Technology£3.8bn5,250p351.0%3.315%7.2%17%49%105%£52mGBPEPS Grth
The Independent Investment TrustIITFinancials£370m667p-1.0%---15%29%83%£16mGBPEPS Grth
MJ GleesonGLEConsumer Discretionary£394m725p143.3%1.610%8.5%15%16%50%£34mGBPEPS Grth
Vedanta ResourcesVEDMaterials£2.5bn886p144.7%-7480%-72%15%46%18%-$10.1bnUSDEPS Grth
Man GroupEMGFinancials£3.1bn193p143.9%-51%16%14%23%58%$344mUSDVolume

Source: S&P CapitalIQ

 

NMC Health (NMC)

This is NMC’s second year as a Monster of Momentum. Does this mean we’re looking at “stale” momentum? Indeed, when a stock has increased in value by about 13 times in the five years since its IPO, it seems only right to ask whether it can keep going higher. In the case of NMC, many of those who follow the company are prepared to proffer the answer: yes, it can go much higher. The reason for the enthusiasm about shares in this United Arab Emirates (UAE)-focused healthcare provider comes down to the combination of growth potential and a track record for delivering on strategic goals.

The market for healthcare in the UAE is growing strongly. The introduction of mandatory health insurance in Abu Dubai and more recently Dubai is fuelling demand. So too is an ageing population, and relatively high occurrences of costly health conditions such as obesity and coronary disease. At the same time, development of the healthcare sector in the country is leading to increased demand for more advanced medical procedures. Having initially focused on doubling its bed capacity in the region, NMC has gone on to add higher-margin services to its offering, such as IVF. The group owns and operates a number of multi-speciality hospitals, as well as managing assets for third parties. It also runs pharmacies and has a distribution business.

The next phase in the business’s development is to move beyond the UAE and to this end it has recently bought two multi-speciality hospitals in Saudi Arabia, as well as announcing a greenfield development. The group initially moved into Saudi Arabia last year through an acquisition and prospects in the kingdom are considered very exciting. The market has similar characteristics to the UAE, with mandatory health insurance and a government commitment to improving healthcare with the help of private sector operators. That said, the recent anti-corruption 'purge' of the kingdom’s elite does cause uncertainty. Indeed, some wind has come out of the shares recently following these events.

NMC is expected to stay on the acquisition trail, but it also has significant capacity for growth based on beds available in its existing hospitals. Broker Berenberg, which recently initiated coverage on NMC, believes the company, which has increased EPS by 3.2 times over the past five years, will be able to increase EPS by 3.6 times in the coming five years to 2023. On this basis, the broker feels the strong share price momentum should continue and puts a 4,000p target price on the shares and sees the potential for 10,000p in five years’ time – what a monster!

Last IC View: Buy, 2,700p, 27 Sep 2017

 

Games Workshop (GAW)

A picture can tell a thousand words, so the saying goes. That certainly seems apt when charting the share price rise over the past year of fantasy-games retailer Games Workshop against EPS forecast upgrades. Indeed, while the share price is up 290 per cent over the past year, very strong trading has led to forecast EPS for the current financial year (to the end of May 2018) being revised 250 per cent upwards since November 2016, while 2019 EPS forecasts are 180 per cent higher than they were a year ago (see chart below).

 

 

Latching on to companies experiencing a trend of earnings forecast upgrades can be a very profitable strategy as share prices adjust to better-than-expected news. This is particularly true for stocks that do not appear to have overstretched valuations, as an unexceptional rating suggests the market does not yet consider expectation-beating trading to be the norm.

It’s therefore good news for Games Workshop fans that its shares’ rating does not look that overbaked, based on a forecast dividend yield of 5.5 per cent, cash on the balance sheet and a multiple of 13 times forecast earnings (although the forward PE rises back to 16 times based on 2019 forecasts). That said, the valuation is fairly high by historic standards. The key question, though, is whether 2017 has been a one-off year when the stars have temporarily aligned for the company or whether the positive surprises will keep coming?

There are some reasons to be cautious about the sustainability of the upgrade trend. For one thing, Games Workshop has a reputation for not being overly concerned about manicuring its results or stage-managing City expectations. So management may not prove very concerned about pandering to investors’ short-term wants – arguably this is a very good thing for long-term shareholders. What’s more, recent trading has been boosted by the very successful launch of fantasy game Warhammar 40k, which is not the type of product event that happens every year. Indeed, EPS is predicted to fall back in 2019, hence the aforementioned rise in the forward PE when looking at longer-term EPS forecasts. What’s more, every part of the group’s business is performing strongly this year, and few companies can expect such across-the-board success to persist for all that long.

That said, the company has made some fundamental changes over recent years that it should continue to benefit from. These include lowering costs, improving its insight into what new products are likely to prove popular, and making more use of technology to engage its hobbyist customer base. The company is also expected to use its growing cash pile to invest more in product innovation, which should spur sales. And belying all this is the fact that, as a large proportion of its costs are fixed, which means any extra sales have a powerful effect on Games Workshop’s bottom line, forecast changes are more likely (on the downside, as well as the upside). So despite a phenomenal run, there are some grounds to hope the ride may not be over yet.

Last IC View: Buy, 2,156p, 19 Oct