Don't be fooled by lovely losers

Sadly, though, while the conclusion of 'buy the losers' looks so clear cut from the screen’s recent experience, it is discredited by the far greater evidence that comes from reams of academic research into momentum investing covering a wide variety of markets and data stretching back as far as adequate records exist. Indeed, the five-year history of the screen tells a story more in fitting with momentum’s billing as investment’s “premier anomaly” (see chart).

The experience of my blue-chip momentum screen over the past three years, specifically the triumph of the shorts, illustrates how easy it is to come to a wrong conclusion when confronted with a seemingly indefatigable pattern, which is actually, essentially a random outcome. Indeed, it is interesting that many commentators point to momentum as having performed particularly strongly over recent years, which arguably would suggest that my blue-chip screen should have behaved 'well' over the period. However, while the screen should reflect the broad characteristics of a classic momentum strategy over time (ie the longs outperforming the index and the shorts underperforming), it is conducted at just a few specific points in time every year (the 15th day of March, June, September and December), which makes it very much its own beast.

From the perspective of this column, this kind of behaviour is particularly important to bear in mind, as most of my screens track strategies that are only updated once a year. Many of these have done well since I started to follow them, starting about seven years ago. However, while it is interesting and potentially useful to observe how these strategies perform, it is good to remember that the data collected does not constitute anything like a long or broad enough road test to draw significant conclusions. Indeed, while it is always useful to track stock screen performance against a benchmark, the prime purpose of this column always remains as a source of interesting ideas for further research rather than a source of off-the-shelf portfolios. I will be reviewing all the screens I run in this column in the New Year, and in-between now and then I will take a break from the screens in order to provide reviews of both the Tips of the Week and the 2017 Tips of the Year.

The tables below detail the performance of the momentum screen (the winners are labelled 'Longs' and losers 'Shorts') over the most recent three-month period and various time periods from one year to the inception date of this screen.

Three-month performance

Longer-term performance

Source: S&P CapitalIQ

While momentum is definitely a phenomenon it pays to be aware of, it is not one that is always easy to profit from. As a strategy it tends to play out over the long term, with frequent bouts of underperformance – sometimes violent ones – and the trading costs associated with near-constant portfolio reshuffling can erode any outperformance.

Below are the blue-chip longs and shorts for the coming period, along with brief write-ups of the longs and some of the factors that may be behind their recent share price strength. The screen is based on identifying the 10 best (longs) and worst (shorts) performing shares between 15 September and 15 December, with classic momentum theory suggesting the longs are more likely to outperform the index and the shorts more likely to underperform. Due to publication timings the period over which the stocks listed in this article are selected is slightly short (15 September to 11 December) and future updates will be based on a full three-month selection period so may vary slightly.

Longs and Shorts

*Includes special dividends

Source: S&P CapitalIQ

Pearson

Pearson (PSON) is the kind of bounce-back stock that has made a 'buy the losers' strategy so effective over recent years. In the case of education behemoth Pearson, the level of negative sentiment towards the stock means some modestly positive news appears to have been enough to send the shares soaring. The company faces a number of structural challenges in its key US market and investors are not convinced by its efforts to address a shift from printed to digital learning materials, nor is the market sure high historic returns can be maintained. However, during the past three months the group released a less-bad-than-expected trading update, which benefited from improved US book inventory trends and cost savings. The company also recently announced the $300m sale of its English-language teaching business, Wall Street English. While the detail of the sale means Pearson will only rake in about $100m cash, the disposal has boosted hopes for future dividend payments.

InterContinental Hotels

The three-month performance period used to select shares for this screen covers a time during which InterContinental Hotels' (IHG) shares retraced their way back towards a year high from their 2017 low. Along the way the shares were helped by an encouraging, although not knockout, third-quarter trading update. Third-quarter revenue per available room was up 2.3 per cent, driven by a strong performance in Europe and China. Meanwhile, growth in the group’s “system size” increased to 4.1 per cent. All of this was good stuff, but arguably not as exciting as the price action from mid-September would otherwise suggest.

Ferguson

Plumbing supplies group Ferguson (FERG), formerly known as Wolseley, has found its shares in favour during the past three months as it sharpened its focus on the thriving US market with the sale of its Nordics business, and reported strong stateside third-quarter results. The company changed its name to match that of its US business in March this year and announced its intention to get out of the Nordic region. So news of a $1bn offer for the Nordic business last month marks an important move in this direction and should leave the company debt-free. Meanwhile, earlier this month the company reported strong organic growth and margin improvements in the US, which should account for over 90 per cent of sales in the current financial year. Trading in the UK is patchy, but the company is accelerating a transformation programme that it hopes will pep up the business.

EasyJet

Shares in easyJet (EZJ) have encountered significant turbulence this year, but the past three months have seen them gain altitude. The key issue for investors has been one of capacity. With demand for flights buoyant, airlines have been adding more planes to their fleets at a rate that has had a negative effect on ticket prices and profitability – a classic dynamic for the airline sector. However, recently this has led to the collapse of a number of airlines with rickety balance sheets – Monarch and AirBerlin – which has reduced supply pressures and left spoils for rivals. For its part, subject to regulatory clearance, easyJet is taking Air Berlin’s old slots at Berlin Tegel airport at a knock-down price. What’s more, easyJet’s full-year results announced last month pointed to the benefits of reduced competition in the form of an improving trend in revenue per seat. Meanwhile, chief executive Johan Lungdren spent £288,450 on shares earlier this month. But while there are many recent positives, with demand for flights continuing to look buoyant and fuel prices at comfortable levels, it may not be too long before this capital-hungry and highly cyclical industry moves to fill the gap left by Monarch and Air Berlin, and capacity becomes a worry again.

Paddy Power Betfair

In the past three months shares in Paddy Power Betfair (PPB) have benefited from news that the maximum stake for fixed-odds betting terminals – known as the crack cocaine of gambling – will be cut from £100 to somewhere between £2 and £50. A cut was expected, and the wide range being considered has led analysts to moot that the regulatory changes may not be too swingeing. That said, the terrible impact this kind of gambling can have on people’s lives means a tougher decision still should not be ruled out should popular concern come to bear. New gambling tax changes in Australia are also expected to hit the group’s business there. As well as some relief over the regulatory environment, the shares may now be benefiting from anticipation of the appointment of new chief executive Peter Jackson in the New Year. The company is expected to finish the year with about £175m cash, meaning the new broom could target acquisitions, shareholder returns or perhaps investment in product innovation following a soon-to-complete unification of group technology systems.

Berkeley Group

Upmarket, London-focused housebuilder Berkeley (BKG) has only recently joined the blue-chip index, but is already making a strong impression. Its shares surged earlier this month when its half-year results reported strong trading. The news was especially welcome due to broad concern about a weakening London housing market, especially at the top end. Indeed, while the group itself did have some cautious words on the subject of the housing market, as far as the share price was concerned it was the numbers that really did the talking. Completions, profit margins and net asset value all powered higher. Meanwhile, the company lifted its five-year profit guidance to April 2021 from £3bn to £3.3bn. Cash also continues to flood in, rising by £286m in six months to £632m. Meanwhile reservations were up by a fifth from the same time last year, although they remain a tenth lower than the same point in 2015, prior to the Brexit vote.

Kingfisher

While third-quarter results from DIY and building materials store operator Kingfisher (KGF) offered little in the way of new news, the numbers seem to have helped get the market behind the group’s ongoing restructuring efforts and the potential for conditions to improve for its French business. For now, France and the group’s UK-focused B&Q chain remain a source of weak trading, but progress continues to be made transforming these operations, even though the disruptions involved in implementing the plan have caused some temporary obstacles. Meanwhile, Kingfisher’s Polish and Screwfix businesses are doing well.

Croda International

Third-quarter results at the end of October from chemicals group Croda (CRDA) were rather mixed, but fortunately for investors they were mixed in welcome measures. Indeed, while the performance of the group’s life sciences division was a bit disappointing and did not benefit from currency to the extent it had in the first half, management was able to report better than expected trading from the personal care division. Given personal care delivers higher margins than the group’s other divisions, the overall effect of the update was positive for prospects.

Ashtead

Ashtead's (AHT) first-half results announcement fell just after the shortened period used for this article to select longs and shorts. However, the news on results day only served to underpin Ashtead's shares' recent momentum. The US-focused equipment hire group experienced a bumper six months, which saw profits rise 23 per cent, boosted by demand related to hurricane clean-up efforts. Management showed its confidence in prospects by increasing capital expenditure plans and announcing an 18-month buyback programme of between £500m and £1bn. The progress made by the Trump administration in pushing forward tax cuts has also aided sentiment towards Ashtead. Meanwhile, from an industry perspective, the group also continues to benefit from a trend in the US away from equipment ownership towards rental. And a robust balance sheet and an excellent track record suggests Ashtead should be in a great position to benefit from future growth opportunities.

Hargreaves Lansdown

A first-quarter trading update in mid-October helped momentum in Hargreaves Lansdown’s (HL.) shares by underlining the attractions of its business model. Indeed, net inflows during the first quarter were a very healthy £1.5bn on the back of new client wins. That compared with £1.1bn in the same period last year. The financial services group’s strategy of competing primarily on quality of service rather than price has helped it continue to grow while maintaining high margins and strong cash flows. Meanwhile pension freedoms underpin the potential for the group to carry on growing and the business is considered to be very 'scalable'. The shares cannot be described as cheap though.