One of the most remarkable truths in stock markets is that prices have a tendency to trend in the same direction. Indeed buying recent winners and selling losers is one of the most profitable habits that an investor can have. This 'momentum' is evident not only in share prices but also in company earnings.
When companies surprise to the upside in their earnings announcements, the share price tends to react similarly. The Stockopedia Momentum Rank blends several metrics that define share price momentum with several metrics that define earnings momentum to help you find the companies most likely to continue to outperform over a 3 to 6 month period.
Our approach mirrors that taken for our ValueRank, Quality Rank and GrowthRank scores. It is inspired by the latest research into momentum (Jegadeesh and Titman, George and Hwang, Seung-Chan Park). The MomentumRank is based on a composite of the following Price and Estimate Momentum Factors:
Price Momentum Factors: Prices have a tendency to trend in the same direction over 6-12 month periods:
Each company in the market is ranked from 1 to 100 for each of these momentum ratios and a composite score is calculated as a weighted average of all valid values. The MomentumRank™ is then calculated between zero and 100 for this composite score, where 100 is best and zero is worst.
NB - when a company has no broker coverage we cannot calculate earnings momentum. As a result the Momentum Rank is calculated using price momentum factors alone.
The momentum research suggests that relative strength is a negative signal in the very near-term (less than 1 month) and the very long-term (3 yrs +) but generally a positive indicator in the medium-term (3-12 months) - we focus on medium to long term factors in this momentum rank.
Work by US finance professor Seung-Chan Park in 2005 found that it was possible to predict the medium-term outperformance of a stock based on the ratio between its 50-day and 200-day MA. His research showed that stocks where the 50-day MA is much higher than the 200-day MA tend to perform better over the subsequent six months than stocks whose 50-day MA is much lower than the 200-day MA. He finds that a long/short momentum strategy sorted based on the 50 day / 200 day moving average ratio generates raw returns of 1.45% per month (1.81% for the top decile and 0.36% for the bottom decline), increasing to 1.64% when risk adjusted.
Work by researchers George and Hwang published in the Journal of Finance has shown that the closer a stock's current price is to its 52-week high, the stronger that stock's performance in the subsequent period. They surmise that investors use the 52- week high as an "anchor" against which they value stocks, thus they tend to be reluctant to buy a stock as it nears this point regardless of new positive information. As a result, investors underreact when stock prices approach the 52-week high, and consequently, contrary to most investors' expectations, stocks near their 52-week highs tend to be systematically undervalued. Academic research by deBondt and Thaler illustrates that 3 year losers have a tendency to outperform 3y winners. This is the concept of mean reversion at work.