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Related Sites Jim Collins OTC Insight Louis Navelliers MPT Review |
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| The Basics | |||||||||||||||
| A simple way to tap markets momentum | |||||||||||||||
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You can spend lots of time, and money, seeking the names of stocks with strong upward trends. But here's a screen that does most of the work for you. By Harry Domash Momentum investing? To some, those words imply a walk on the wild side. Despite its dubious reputation, however, momentum investing works -- just not in a bear market. Back in the 1990s, the strategy was all the rage, and newsletters were the hot medium for investors seeking an advantage in the momentum game. Newsletters such as Jim Collins OTC Insight and Louis Navelliers MPT Review (see the links at left under Related Sites) compiled impressive momentum-stock-picking records that established a seemingly permanent residence on Hulbert Financial Digests list of top performing newsletters. In fact, despite less-than-stellar records during the most recent bear market, the Collins and Navellier newsletter returns ranked No. 2 and No. 4, respectively, on Hulbert's 15-year list. In 2003, thanks to the strong market, momentum strategies shined once again. The Collins newsletter stock picks, for instance, were up 38% in the first six months of 2003 alone. If youre interested, you can subscribe to these fine newsletters, but they're not cheap. Collins newsletter runs $295, and Navelliers will set you back a whopping $995 for one year. Despite the cost, the number of subscribers is rising, thanks largely to the strong stock market of 2003.
But there's another option. Do-it-yourselfers can use MSN Moneys Deluxe Screener to come up with many of the same stocks that the Street's top newsletters do -- and save plenty of bucks in the process. Momentum basics Momentum investors swing for the fences. For them, 15% or 20% returns in a years time arent worth talking about. Instead, they seek out stocks with the potential to double or triple within just a few months. What do they look for? Three things, typically: a strong price chart, rapid earnings growth and recent positive changes in earnings-growth forecasts. Generally, momentum types dont spend much time scrutinizing fundamentals, but Collins and Navellier do add basics such as profitability and sales growth to the mix. Momentum investing is not a buy-and-hold strategy. Momentum investors typically hold a stock for a few months. However, they monitor their holdings daily and sometimes sell much sooner. With these priorities in mind, I've built a robust momentum-stock screen based on the MSN Money Deluxe Screener. My screen looks at five categories:
Here's the screen. To see what goes into it, read on. Relative strength This may sound counterintuitive, but research shows that stocks that have already outperformed the market over the past 12 months are likely to continue their winning ways, at least in the short term. Limiting your picks to strong 12-month performers is crucial to momentum strategies, and relative strength is the tool of choice for gauging performance. Relative strength, or RS, measures how a stock has performed compared to the overall market over a specified timeframe. For example, a 12-month relative strength of 75 means that a stock has outperformed 75% of all stocks, in terms of price performance, over the past 12 months. MSN Moneys Deluxe Screener includes three-, six- and 12-month relative strength parameters. Most momentum strategies use the 12-month number as the primary selection parameter. Require a 12-month RS of at least 90, and higher is better. Screening parameter: 12-month relative strength >= 90. Although the 12-month RS is the most important, checking the shorter timeframe RS helps to ensure that the stock isnt burning out. All stock charts ebb and flow, so the shorter the timeframe, the less stringent the requirement. Screening parameter: Six-month relative strength >= 75. Screening parameter: Three-month relative strength >= 65. Earnings momentum Now that weve pinpointed stocks with strong price charts, well check the earnings-momentum side of the equation. Earnings momentum starts with strong quarterly year-over-year earnings growth. You could use the most recent reported quarters figure, but I prefer the current quarters forecast growth, because it better reflects current expectations. In either case, fast growth is the name of the game, and 15% year-over-year EPS growth is about the minimum to qualify a momentum stock. However, higher isnt always better because very high figures may signal that the earnings in the year-ago quarter were abnormally low. Screening parameter: Current quarter growth rate >= 15. Positive momentum in consensus earnings forecasts, meaning that at least some analysts have upped their estimates, is a necessary ingredient of the momentum recipe. MSN Moneys Deluxe Screener has a handy parameter for insuring that qualifying stocks meet that requirement. Screening parameter: Earnings estimate increased since "in the last quarter." Finally, in the earnings department, momentum investors look for a positive earnings surprise in the last reported quarter, meaning that the reported earnings exceeded the consensus forecasts. This requirement is well-founded because a variety of studies found that stocks with recent positive surprises outperform the overall market. Screening parameter: Recent quarter surprise % >= 5. Revenue and revenue growth The parameters above are sufficient to define momentum stocks in the classic sense. But stocks meeting those requirements alone will include disasters waiting to happen. So well add some fundamental requirements to filter out some of these time bombs. Few companies can make money without selling something to somebody. Establishing a minimum annual sales (revenue) volume weeds out stocks that dont have solid businesses. Most publicly traded corporations sell products and/or services totaling well into the hundreds of millions of dollars annually. I set the limit at $40 million annually, which equates to $10 million per quarter -- peanuts for most companies. Screening parameter: 12-month revenue >= $40,000,000. Just as earnings come from sales, real earnings growth requires sales growth. Sure, a company can grow earnings for a while by cutting costs, but that strategy eventually peters out. I set the quarterly year-over-year sales growth minimum at 15%, the same as the required earnings growth. Screening parameter: Revenue growth quarter versus quarter >= 15. Return on equity Now lets take a look at profitability. ROE measures a company's profitability by comparing its net income to shareholders equity (book value). If you do the math, youll find that ROE is a speed limit on self-funded growth. That is, a company cant grow earnings faster than its ROE without raising cash by borrowing or selling more shares. For instance, a 15% ROE means that the company cant grow earnings faster than 15% annually by relying only on profit to fuel growth. Of course, many companies do raise cash by issuing stock or borrowing, but both alternatives reduce earnings-per-share growth. Momentum screens tend to turn up newer companies that arent as profitable as slower growers, but setting the minimum ROE at 5% weeds out the least profitable candidates. Screening parameter: Return on equity >= 5. Trading and volume Finally, well use the share price and trading volume to rule out the most risky stocks. Stocks trade at very low prices for only one reason: They are out of favor with the investment community. That negative sentiment may be misplaced, but momentum investing is about riding stocks that the market likes to new highs. Avoid stocks trading below $5. Screening parameter: Previous days closing price => 5. Trading volume is the number of shares traded daily, on average. Very low trading volumes signal lack of interest, just the opposite of what momentum investors need. I set the minimum trading volume at 20,000 shares, which most momentum candidates should meet handily. Screening parameter: Average daily volume last quarter >= 20,000. You can see how Navellier rates the stocks turned up by your screen by using the link at left. He grades stocks "A" through "F" where "A" is strong buy and "B" equates to "buy." You can get the grades free; all you have to do is enter your e-mail address and ZIP code to use the feature. When to sell Momentum stocks get hammered when something goes wrong. Consequently, momentum investors must act quickly at the first sign of trouble. Heres what to look for:
At the time of publication, Harry Domash did not own or control shares in any of the equities mentioned in this column. | |||||||||||||||
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