Hunting For Momentum? Here's Where You'll Find It...

20th Mar '19 by Jack Brumby

14 comments 9165 reads

Momentum is a powerful factor and there is a body of academic work out there that proves this across countries and time periods.

One of these studies, “Analyst Forecasts and the Cross Section of European Stock Returns”, (McKnight and Todd, 2006) is the basis for Stockopedia’s Earnings Upgrades Momentum Screen, which has come to life in recent weeks.

A number of new companies pass the following criteria:

% 1m EPS Upgrade FY2 > 5
# 1m Upgrades > 1
# 1m Upgrades > 1 * # 1m Downgrades
# Brokers > 3

McKnight and Todd’s research found that an “earnings upgrade” portfolio materially outperformed a “sell” portfolio - by more than 16% per year.

As for why exactly this might be, McKnight and Todd posited two factors: conflicts of interest in the investment banking industry (leading to unduly optimistic forecasts) on the one hand, and cynical investors adopting a “wait-and-see” approach to good news on the other.

The study’s central insight is that bad news travels quickly, but good news travels slowly. This means that we can sometimes invest after the first upgrade and profit from the upgrades that are likely to follow.

McKnight and Todd also found that stocks with a lower variance of estimates performed better than those with a higher variance of estimates, suggesting that while companies with improving broker upgrades are good, those with improving estimates that are closely grouped together are even better.

So, what are these companies, what’s driving their improving prospects, and should we be re-positioning our portfolios to take advantage of a common trend?

Screening for upgrades

The “Sector” column in the table below gives an instant hint as to what’s driving this re-population of the Earnings Upgrade Momentum Screen:

Name	Mkt Cap £m	Sector	%1m EPS Upgrade FY1	%1m EPS Upgrade FY2	# 1m Upgrades	#1m Downgrades	# Brokers
Lonmin	196.4	Basic Materials	52	18.4	2	0	8
Ferrexpo	1,527	Basic Materials	0.41	14.7	3	0	11
EVRAZ	8,747	Basic Materials	12.7	12.9	3	0	7
Clinigen	1,258	Healthcare	0.41	10.8	3	0	4
GMK Noril'skiy Nikel' PAO	27,041	Basic Materials	8.35	10.0	4	2	11
Cairn Energy	1,023	Energy	-15.3	9.86	2	0	14
Capital & Counties Properties	2,158	Financials	-2.16	9.31	3	0	9
Commercial International Bank Egypt SA	4,302	Financials	3.32	7.34	3	0	10
Anglo American	28,176	Basic Materials	7.68	6.22	13	0	24

The majority of new entrants to the screen over the past month or so are Basic Materials stocks. Rallying copper and gold prices, combined with iron ore supply issues in Brazil, and improvements in Chinese demand due to tighter steel markets are all providing favourable tailwinds in the mining sector right now.

Taking the five miners above and adding in Rio Tinto (which also makes the Earnings Upgrade Momentum Screen) into a temporary portfolio, we can see that these miners are also highly…

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brucepackard

20th Mar '19

Lonmin (LON:LMI) as a superstock? Really? It's only ranked high on the momentum because it looks like the Sibanye deal will actually complete - which was rather doubtful for a while. Take a look at the 5 year chart instead.

KEL AKACHA

22nd Mar '19

informative

AnonymousUser537114

Very helpful analysis, but begs several questions that go beyond the numbers and need further development. Sorry, but I can't answer them:

How representative is a sample of only 9, even if filtered for momentum?
Yes, Basic Materials dominate, but this may only be short term, and linked to expectations rather than reality. Who is buying Basic Materials companies and why? What is the back history here?
What about the four out of nine that buck the trend? Are they all niche market companies, or is there another particular explanation for each of them?

Hope this helps.

alison ruggles

I like it - momentum investing is my favoured, bu hard at the moment. I have EVR but am naturally worried about only 1.5 times cover

Rusty2

23rd Mar '19

I had a look at that screen, yes it's done well over the last 3 months, however most of the growth was 1-3 months ago, the last month it is only up 1.6%, this last week it was down 2.2%, so you can see momentum can quickly change. All the stocks on the screen have been on there less than 2 months so probably don't account for the 20% rise, Rio Tinto (LON:RIO) is the oldest selected on 7 February, 2019, so it is a frequently traded screen, about 10 shares a month bought and sold, so 20 transactions is a lot of transaction and stamp duty costs. Would be interested in which actual shares made the profits. I see Rio Tinto (LON:RIO) has been bought and sold 5 times this year and Ferrexpo (LON:FXPO) has been 4 this year, once with only 3 days in between. My feeling is Basic materials has probably peaked and I have missed the boat. Out of the ones listed I'm most keen on Anglo American (LON:AAL) even though it does not currently qualify for the screen.

HumourMe

Hi herbie47,

so it is a frequently traded screen

I don't think you can assume that. The screens all work on the basis of:

We build a portfolio of equal weighted positions across the top 25 candidate stocks for each stock screen and rebalance the portfolio quarterly.

https://www.stockopedia.com/co...

So they are only about selection criteria, they buy 'blindly', sell after a quarter, ignore costs (and spread) and also ignore dividends.

Given that , if the underlying strategy usually:

selects small caps, then a spread adjustment needs to be made.
selects significant dividend payers (some value based screens), then a typical dividend needs to be factored in (based on typical holding periods and yields).
times buys or uses stops (e.g. CANSLIM) then returns will be different, as shares that screen in may never be bought or those bought might be stopped out and never given the opportunity to recover (when holding for a quarter might have worked)

Any screens performance needs to be treated with a pinch of salt; relative comparisons are more useful than absolute ones.

I'm not saying that they are without merit. They give excellent insight into different selection criteria. I'd like more stats (e.g. median draw down of components and portfolio, different stats given for different exit strategies etc..). They also give me serious pause for thought on trying to time entry/exits! Also considering the timing issue should I even care about individual shares if my portfolio is performing ok? (I wish).

InvestorJohn

How do you see what is held as part of the screen? Or what has been there etc this would be useful for me...

The best we have at present, is when shares last qualified prior to today (highlighted), available, if you are a subscriber (example from CANSLIM with UK & Europe subscription), otherwise blurred I think.

5c9658f00a13fAnnotation_2019-03-23_16003

If a share is selected on a screen then you can click on the qualified date it will give you the dates it entered and exited. However as HumourMe says this does not seem to happen as it's quaterly adjusted.

OK thanks for that information, so we don't know which shares form part of the screen then? How can they select 25 shares if only 14 or 3 qualify?

They can't. I've flagged your question to the green talky icon thing, so hopefully someone will respond next week.

Either the missing places are counted as cash or the qualifying shares are allocated proportionally.

Oh one further thought. For those that screen in a lot of shares and then sort by a criteria, it is possibly the sort criteria alone, that determines or contributes significantly to subsequent performance. I'd like to see screens based just on the various sort criteria to eliminate this as an explanation!

iwright7

24th Mar '19

Whilst the Earnings Upgrade Screen has found manly Basic Materials companies, it has also found a sector group within striking distance of their 52 Week Highs. Investor behavioural research points out that 52 Wk High's lead us to underreact to +ve news, which causes further gentle upward drift. In addition such 52 Wk High companies often go on to Earning Surprise to the upside, so we may see a number interlinked Momentum factors kicking in. I am going to research into this sector further - The party may not be over just yet. Ian

Edward Croft

25th Mar '19

We always equal weight the qualifiers. There's no cash position held in the tracking... apart from odd lots. If there are only 3 stocks... they are fully 'invested' in 3 stocks.

Adrianus Ploeger

26th Mar '19

Usefull, sure. I am new on this Website and appreciate the detailed consult and observations here.

Hunting for Momentum? Here's where you'll find it...

Screening for upgrades

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Jack Brumby

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