Skip navigation

Resource Centre
The Wise Investor

Resources
Getting Started
The Wise Investor
Online Investing
Glossary
Book Centre
globefund.com Alert
Table of Contents
Put your financial adviser on a leash
February 11, 2000
100% Foreign content for your RSP
December 22, 1999
Tax Loss Selling or Dealing With Your Mistakes
November 26, 1999
Life Stages of your RRSPs
November 12, 1999
Just give me boring (but great) rates of return
November 3, 1999
De-mystifying Demutualization - part Two
October 25, 1999
De-mystifying Demutualization - part One
October 19, 1999
Seg funds for the simple minded
September 14, 1999
The interest rate game Part 2
August 12, 1999
The interest rate game Part 1
July 30, 1999
Choosing funds: Five for the long run
July 14, 1999
New Funds: To buy or not to buy
July 2, 1999
Making sense of momentum investing
June 18, 1999
Rating the fund managers
June 4, 1999
Resource recovery hinges on supply and demand
April 30, 1999
Tech funds draw strength from favourable trends
March 24, 1999
Withdrawing from your RRSP
March 9, 1999
The economic implications of the euro - An interview with Ranga Chand
February 12, 1999
Underperforming small-cap funds have strong upside potential
January 29, 1999
How to pick a winning equity fund portfolio
January 15, 1999
View the Weekly Insight archive
   

Making sense of momentum investing

Related articles from The Globe and Mail

Momentum style sends 20/20 soaring
- June 17, 1999

Picton's fund gains momentum with pros
- February 27, 1999

Winning style a matter of momentum
- February 4, 1999

DAVE PICTON
Manager, Synergy Canadian Momentum Class fund
Friday, June 18, 1999

Of the four major investment styles (momentum, growth, value and small cap), momentum investing is perhaps the most difficult to characterize. While most investors can explain the differences between the value and growth investment styles, many believe that momentum investing is simply buying ‘high flier’ stocks that are driven strictly by hype and/or speculation. With the strong performance of the momentum style in 1998 and thus far in 1999, it’s important that investors understand what momentum investing is and how it can complement other styles within a portfolio.

Momentum investing in its simplest and purest form is about looking for companies that are changing for the better. A momentum investor wants to find the companies that are improving at a faster rate than the market or than investors currently expect. Momentum investors also seek out average companies that are becoming good or good companies that are becoming great. It is in this transition that the momentum investor makes his or her money.

With this in mind, I like to compare momentum investing to going for a train ride. I try to board the train after all the preparations for the trip have occurred and the train is just leaving the station. I am happy as long as the train accelerates and then maintains its speed. However, if the train begins to slow down, I pull the emergency cord and get off.

I use this analogy because it gives you a visual image of what I do as the manager of a momentum fund. I’m looking for companies that are on a roll, that meet and beat earnings expectations and have forward momentum. I want to see a fundamental improvement in the way they do business that is reflected in improving earnings for the company and a stronger share price.

In search of earnings momentum

How does this “fundamental improvement” take place? One example occurs when a corporation implements a new strategy and places a significant amount of resources behind that initiative. The new strategy could be anything from the launch of an innovative product to a restructuring of the company’s divisions to a different management approach. If this strategy is implemented successfully and earnings improve, the company becomes more positively perceived in the marketplace. This improvement leads to higher valuations being paid for the company. I like to buy a company when it shows initial signs of success and starts to change investor’s perceptions for the better.

There are four main criteria I use to find companies with strong momentum.

  • earnings acceleration (when a company’s earnings are increasing at faster rates than in the past)
  • upward changes in analysts’ earnings forecasts for a company
  • positive earnings surprises (when a company delivers better earnings performance than most investors or analysts anticipated)
  • good relative strength (when a company’s stock price is increasing faster than the overall stock market).
All of these criteria indicate that the company is changing for the better. This quantitative analysis is accompanied by qualitative analysis. In my qualitative analysis, I do fundamental research on the company and its industry. I look for companies with strong leadership, a competitive advantage and financial strength. The company must have a strategy that will sustain its momentum for more than just one quarter.

Momentum managers typically have a much shorter investment horizon than other types of fund managers. They are rewarded by significant upward movements in stock prices that can occur over shorter periods of time. Growth investors, on the other hand, tend to focus on the longer term. They want to see consistent earnings growth for a three-to-five year period. As a momentum investor, I’m looking for companies that may not necessarily have a five-year growth trend, but rather a recent acceleration or increase in their growth rate. They can be resource companies, high-tech companies or financial companies, but what I’m most concerned about is a recent acceleration in their earnings or earnings potential.

Let’s look at a couple of examples of momentum stocks. JDS Fitel is a high-tech company that makes fibre optic components that allow more information to travel down information pipelines. JDS Fitel has been a strong momentum company due to the growth in communications traffic; it consistently beat earnings expectations, had great relative strength and had its earnings’ forecasts continually revised upwards by analysts. Then JDS Fitel merged with Uniphase. Now this company has become even stronger and looks to be the number one fibre optics component supplier for the future. This company definitely fits all my criteria for a momentum stock.

Another example of a momentum stock is Domtar, a forest products company. Management at Domtar embarked on a plan of adding shareholder value and dumped some of their unsuccessful enterprises to focus on more profitable lines of business. They instituted an internal return on equity target and positioned the company as a low-cost producer. Although these changes were made in a negative operating environment, the changes themselves led to positive earnings surprises and to analysts’ forecasts being revised upwards. A growth investor might not choose this stock, but it’s a good choice for a momentum investor.

Managing risk, staying disciplined

I believe that a fund manager’s ‘sell’ discipline should be as strong as his or her ‘buy’ discipline. That’s why I use the same four quantitative criteria to identify companies in my portfolio that should be sold. If a company surprises the market with earnings disappointments, I sell immediately because I have found that companies rarely have one bad quarter. My experience has taught me to eliminate my exposure as soon as the stock disappoints and to look for better opportunities.

Risk is an increasingly important area to focus on, particularly given high stock market valuations and the potential for increased volatility. Momentum investing shouldn’t be about buying stocks that are being driven up on speculative hype. I insist that companies I hold meet my positive fundamental change criteria — that’s one way of controlling the risk – and is diversified across sectors.

Dave Picton is manager of Synergy Canadian Momentum Class. The fund currently has approximately 40 Canadian holdings plus full foreign content, with the largest representing a weighting of 5% or 6% of the portfolio. The fund is 100% RRSP eligible.

Important information about Synergy Mutual Funds is contained in its prospectuses. Obtain copies from your financial advisor and read them carefully before investing. Net asset values and investment returns will fluctuate.

The stock information contained in this article is for information purposes only. Portfolio holdings mentioned in the Synergy Canadian Momentum Class portfolio are subject to change at any time at the discretion of the portfolio manager.

Back to top

Back to top