24 red hot stocks

It's an exciting time for this column. The first of the stock screens I devised specifically for our screening pages is turning 10 years old. 

In reality, the periods over which people choose to assess performance are somewhat arbitrary. What’s more, any inferences are overshadowed by the fact that 'past performance is no guide to future returns'. But a decade still feels significant and hopefully not just as a testament to the staying power of this column’s author – it takes a special kind of nerd.

It’s probably fair to say that as the first of the screens to turn 10 years old, my Monsters of Momentum screen is not one of this column’s real standout stars. All the same, it has done very well over the decade. Indeed, if someone told me the performance it was to go on to achieve 10 years ago I probably would have scoffed at them, or disappeared off to set up a hedge fund – although I hear the hours aren’t great. 

The screen’s cumulative total return has come in at 283 per cent over the past decade. That’s almost five times the 58 per cent over the same period from the FTSE All-Share index from which stocks are selected. Even after adding in a notional annual dealing charge of 1.5 per cent, the performance stands head and shoulders above the All-Share at 229 per cent. That said, the screens run in this column are considered as sources of ideas for further research rather than off-the-shelf portfolios.

As the name of the screen suggests, its premise is rather racy. Essentially the screen looks for shares that are shooting higher and showing little sign of slowing their ascent. As well as testing share prices, the screen wants to see rising dealing volumes and strong forecast growth. 

Piling up such high demands can sometimes end in major disappointments. Fortunately, though, when things go well for this screen, they tend to go very well indeed. The stellar performance of the screen over the past 12 months demonstrates this. While half the stocks highlighted underperformed the index – one by a gut-churning amount – the disappointments were substantially more than offset by amazing runs from three of last year’s 10 picks: CMC Markets (CMCX) Avon Rubber (AVON) and Polymetal International (POLY).

12-month performance

Source: Thomson Datastream

The pandemic has played a major role in the performance of CMC and Polymetal, so the very strong 12 months on the whole was partly thanks to a lucky break around Covid-19. 

Looking back at the past decade, I am surprised by the consistency of year-on-year outperformance achieved. The accompanying table details the screen’s 10 12-month performance periods relative to the index. The screen has only underperformed in two of the periods. This year was in fact its most significant outperformance, although only the fourth best performance in absolute terms.

Another surprising feature of this screen for me is its maximum drawdown on a total return basis. The maximum drawdown measures the most the screen has dropped from a high point. In the case of the Monsters of Momentum this is 32.2 per cent, which is actually less than the maximum drawdown from the FTSE All-Share of 35.3 per cent. 

However, no one should be lulled into thinking this strategy is not high risk. One of the two years the screen underperformed was quite dramatic. What’s more, the screen’s beta, which measures its sensitivity to movements in the FTSE All-Share over the past 10 years, is very high at 2.6 times. 

Overall, though, as far as the past decade is concerned, amping up the well known phenomenon of momentum has done well. The screen’s full 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 year no stocks pass all the screen’s criteria, which is principally due to the forward earnings test. That said, pretty much all the stocks failing on this earnings growth criteria, but passing on all others have recently seen strong upgrades to forecasts. Forecast upgrades can be a stronger momentum signal than forecast growth itself. Indeed, a focus on upgrades has served another one of the momentum screens followed by this column (Great Expectations) extremely well since inception (a near six-fold return in just under nine years).

On that basis I’m not overly concerned that all the stocks highlighted by this year’s screen have passed on a weakened criteria that allows them to fail one of the non-price momentum tests. That’s not to say we won’t necessarily see the screen bomb, past performance after all is not a guide to future returns. Still, it's nice to have 10 strong years to look back on.

The 24 stocks passing the screen on its weakened criteria are listed below ordered from highest to lowest three-month momentum. I’ve also looked at the three stocks showing the strongest three-month momentum at the time of writing.

24 RED HOT STOCKS

Source: FactSet

*Foreign FX converted to £

Dignity

The surge in the shares of funeral provider Dignity (DTY) over recent months should be regarded more as a big sigh of relief from the market rather than a jump for joy. The company became something of a victim of its own success a few years ago. Traditionally, it had viewed the funeral business as so reliable that it piled debt high while also jacking up prices to boost profits. However, profitability got so good it started to attract not only competition but also regulatory ire.

The competition and markets authority (CMA) has been talking about introducing price caps. While these remain on the agenda the pressure on the industry from Covid-19 means the CMA says it will not act immediately. This, investors hope, will give Dignity the time it needs to rein in costs and cut back on capital expenditure so that it will be able to cope with the new rules without going cap in hand to the market. 

Dignity still looks a troubled company, but it does not take much good news to make shares rush higher in such situations. With net debt still standing at more than twice the market cap, the price is likely to remain volatile. 

Kainos

Unlike Dignity’s share price run, in the case of Kainos (KNOS) the recent run definitely is a jump for joy. The group looked well set when it came into 2020. It’s IT consulting services were not only in hot demand for implementing based on HR software Workday it also looked set to benefit from a potential splurge in public sector spending following Brexit-related delays.

After reporting strong full-year results to the end of March, which included an 18 per cent rise in sales, the company has twice had to update the market to say it is doing better than expected. Most recently, this month Kainos said trading was “materially ahead” of expectations due to huge demand for its digital transformation services from public sector clients. At the same time, working from home means consultants are busier and costs have been saved from reduced recruitment, training and travel spending.

Consensus forecast earnings for the next year have been upgraded by 84 per cent over the past three months. So while the shares’ rating is dizzying and some of the recent tailwinds may reverse – especially those related to costs – there’s lots to like from the perspective of momentum.

AO World

Online white goods retailer AO World (AO) has benefited from changes in shopping habits that have been encouraged by Covid-19. Earlier this month it released an unscheduled first-half trading update reporting 57 per cent year-on-year sales growth, which caused the shares to jump over 30 per cent. 

The update was of particular encouragement for AO fans because it suggests the acceleration of the move of consumers online that occurred during lockdown is continuing despite the reopening of bricks-and-mortar shops. Another cause for jubilation from the update is that the company achieved particularly strong growth in Germany – 84 per cent – which suggests there could be a major opportunity to expand in Europe.

The update was thin on news about profits. It is hoped that the German business will soon be able to report positive cash profits (EBITDA) at periods of peak trading before becoming profitable in 2022. Increased scale should also help the profitability of the UK business, although additional costs related to Covid-19 are likely to weigh on the first half.