What are we looking for?
Canadian-listed stocks exhibiting strong price momentum.
Momentum stock strategies typically display high turnover and high volatility in short time periods. They can also exhibit sketchy fundamentals and may be driven by irrational sentiment in the market. Therefore, they are not for the more risk-averse investor. However, momentum stock strategies can also exhibit dramatic outperformance over the long term. Regardless of the pitfalls, momentum stocks can supplement a well-rounded portfolio or as an additional input into stock selection.
Momentum can sometimes refer to company sales, earnings or analyst estimates. Today, I focus on traditional momentum, which is based on a stock’s price movement. Stocks are ranked from the current CPMS Canadian universe of 707 stocks and are based on the following factors:
- Three-month price change;
- Six-month price change;
- 12-month price change.
Additionally, stocks are only included when they have at least a $500-million market capitalization and a positive three-month price change.
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.
What we found
I used CPMS to back-test the strategy over two decades, from January, 2000, to December, 2020. During this process, a maximum of 20 Canadian stocks were purchased and equally weighted at the start of each quarter, with a maximum of five stocks for each sector to prevent overexposure to one sector. Stocks would be sold before the next quarter only if their rank dropped below the 40th percentile in the CPMS Canadian universe, otherwise they would be held for the entire quarter.
Over this period, the strategy produced an annualized total return of 18.6 per cent, while the S&P/TSX Composite Total Return Index advanced 6.2 per cent. Although the strategy produced dramatic outperformance, there are some caveats to be aware of. Standard deviation, a measure of volatility, was 21.6 per cent for the strategy, while the benchmark measured 14.1 per cent. Strategy turnover was also high, at 290 per cent, meaning stocks were changed almost three times each year. However, accounting for the potential of large outperformance, momentum strategies can be a worthwhile consideration for investors with higher risk tolerance. Today, 20 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.
Michael Pe, CFA, is a product manager for CPMS at Morningstar Research Inc.
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