What are we looking for?
U.S. stocks that have displayed upside price momentum with a positive earnings-growth outlook.
The screen
More than 60 per cent of stocks on the S&P 500 have a positive return quarter to date, and the index is up almost 9 per cent from the dip at the start of November. With upswings like this, investors may be hesitant to invest, fearing volatility in the near future.
Although cautiousness is warranted, many times upside momentum begets more upside momentum. Picking stocks with recent upswings can produce added returns, at least in the short term, for those willing to take on the risk.
I used Morningstar CPMS to look for stocks that have displayed high positive price momentum and attractive earnings growth potential.
Our criteria included:
- Three-month total return (price and yield);
- Six-month total return (price and yield);
- Expected growth of EPS (earnings per share) for the current year (EPS estimate for the current year versus actual EPS last year).
To alleviate some of the added risk that comes with momentum-style stock picking, stocks are only purchased in the strategy if they have a market cap of at least $2-billion to ensure they are not smaller-cap stocks, which pose higher risk and are more susceptible to volatile price swings. Stocks must also have a positive three-month total return and an expected EPS growth for the current year of at least 8 per cent.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used CPMS to back-test the strategy from April, 2004, to November, 2016. During this process, a maximum of 12 stocks were purchased and equally weighted with a maximum of four stocks a sector, to mitigate sector concentration risk.
Stocks would be sold if they fell outside the top 40 per cent of the ranked universe, if the stock's EPS growth outlook for the current year fell below minus 5 per cent or if the stock's three-month total return fell below minus 10 per cent.
Over this period, the strategy produced an annualized total return of 15.6 per cent, while the S&P 500 total return index advanced 7.8 per cent. Today, 12 stocks qualify for purchase into the strategy and are listed in the accompanying table.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here. Momentum-style investing tends to have increased risk of large price volatility.
Michael Pe, CFA, is an institutional product specialist for CPMS at Morningstar Research Inc.