Compass (LON:CPG) is on a roll and looks like it will keep going higher

When it comes to the long-term drivers of stock market profits, momentum is one of the most powerful forces available to investors.

Strong and persistent trends in both share prices and company earnings have been found by researchers to be highly predictive of future returns over the medium term. And in Compass (LON:CPG) there is evidence of both factors being in play.

The company has just reported a solid set of numbers in its third quarter trading update with underlying revenue at 109% of their 2019 levels and operating margins widening above 6% despite inflationary pressures.

The power of price strength

Compass operates in the Hotels & Entertainment Services sector and has a market cap of £32,672m ($39,344m). Shares in the company are currently trading at 1891p and they've been on the move over the past year, with the price up by 23.8% relative to the market.

A track record of price strength features in a wide range of investment strategies because it's an instant measure of how a stock has performed in comparison with a benchmark. It's also a useful indicator of market sentiment. And while there are no certainties about which way a stock will move next, studies into near-term price performance show that recent price strength can often persist into the future. For that reason it's just as interesting to growth and value investors as it is for momentum and trend traders.

Studies by leading experts on momentum show that stocks with the strongest price strength can keep up the pace for anywhere up to one year, as investors increasingly buy into them.

All eyes on new highs

Persistent, medium term price strength can often be the first clue to finding stocks that are trading at, or close to, their 52 week highs. The one-year high is a hugely influential measure of a stock's popularity. But while it can be a deterrent to some investors (who fear that they've missed their chance), research shows that stocks hitting new highs often continue rising in price.

Research shows this happens because investors are cautious about bidding high performing shares any higher (even if they deserve it). Psychologists call this anchoring. As humans, we often take our time when it comes to changing our opinions in the face of new information - even when it's good news.

This emotional tug-of-war often ends with the ‘new high’ stock drifting higher in price over the coming weeks and months. The upward trend is called “post earnings announcement drift”. As the news sinks in, momentum takes over and the price moves higher.

At 1891p, shares in Compass are currently trading within 1.28% of their 52 week high price - and that suggests that the market likes what it's seeing from the stock. By comparison, its one-year low price stands at 14.1p. 

Markets love nice surprises

Momentum in stocks isn't just about price trend; it's also about momentum in earnings. Many investors want to see consistent growth and punchy earning progression in stocks, and nothing says that more than a company that beats earnings expectations.

Firms that with financial results that beat analyst forecasts can see their share prices surge, but surprisingly the prices of high performing shares can be slow to move when they publish positive earnings news. Research shows this happens because investors are cautious about bidding high performing shares any higher (even if they deserve it). Psychologists call this anchoring. As humans, we tend to take our time when it comes to changing our opinions in the face of new information - even when it's good news.

This emotional tug-of-war often ends with the ‘new high’ stock drifting higher in price over the coming weeks and months. The upward trend is called “post earnings announcement drift”. As the news sinks in, momentum takes over and the price moves higher.

In its last set of financial results, Compass beat earnings expectations and consensus forecasts for the coming year have since been upgraded. What's more, in this morning's trading statement, management increased revenue guidance from around 30% growth to 35% in the year to September 2022. Margin expectations have been tempered slightly due to a high influx of new business and inflationary pressures.

What Stockopedia's Momentum Rank says about Compass

For investors considering whether to buy, hold or sell the stock, the question now is whether this price run will continue. Stockopedia’s own data points to a jarringly simple stock market truth amidst the daily whirlwind of financial data: share prices that have gone up tend to keep going up.

It sounds almost astonishingly simple but people instinctively distrust this momentum effect - surely successful investing can’t be so easy? One of the most convincing explanations for this stock market factor is the conservatism bias - the idea that people are slow to revise their expectations when presented with new information.

That means that when the market finds a stock breaking new all-time highs or beating broker estimates it tends to undervalue this development. The rational investor can take advantage of this mispricing. Stockopedia’s Momentum Rank is a convenient way of summarising the momentum attributes of a stock - Compass's Momentum Rank is currently 99, putting it in the top fifth of companies in the stock market. 

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