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11 Jan | Momentum Investing

It’s a new year and we’re back on our momentum kick, screening for UK shares that tick a number of boxes in terms of debt, liquidity, growth, profitability and importantly, momentum.

Why is momentum so important? If you’ve ever picked up a beginners investment book, many of the first investment lessons that are rammed home are momentum lessons, they’re just not referred to as such at that early stage in your development. Remember “let the trend be your friend” and “never catch a failing knife“? Momentum lessons, the both of them.

At an overview level, if something has been doing something for the past 12 months, then the probability that it will keep on doing that very same thing – in the short term at least and with all things being equal – should be more likely than not.

Applying that logic to the real world, if a company reports a bunch of sound fundamentals – in our screen, represented by exceptional levels of debt, liquidity, growth and profitability – and has continuously added to it’s share price over the past 12 months, if it follows the same stringent business practices in the following 12 months and nothing drastic happens on a macro-economic level to its market or the economy as a whole, doesn’t it follow too that there is no reason for that momentum in price to end.

Okay, that’s a super simplistic take on things. Obviously, investor opinion changes and things never stay the same on any level. But simple is a good place to start, as long as your logic is sound.

As an investor that’s what I’m looking for. I want simple. I want to invest in a company that has it’s debt levels in check and is diligent in maintaining those levels. I want a company that can service it’s short term debt ten times over and still have cash to burn without running to its local commercial bank for costly short term finance. I want a company that will take those same measures again this year that it took last year. The measures that led to the price momentum. And, again, may well lead to the price momentum continuing into the next 12 months.

Your criteria will and should differ to mine but having your criteria mapped out is an important step in defining yourself as an investor. It also takes a lot of the guess work out of investing.

Adding momentum elements to those criteria is almost like a adding a quality check to your criteria. It’s like saying, all of these companies are meeting my requirements in terms of profitability, growth (insert your criteria here), and they’re piling on the price to boot. It’s a check that the market places the same value on your criteria as you do.

Obviously momentum investing is not for everyone. There are investors out there that look for companies just turning the corner. Any screen with momentum elements are not going within a bull’s roar of those listings.

By adding momentum criteria you may too be screening out a number of highly rated companies whose potential valuation has yet to be realised by the market.

And be aware, when a turn in momentum comes for a company that has been piling on the the price, it can be a drastic turn. For companies showing strong momentum it pays to be a little cautious with the distance of those stop-losses. Maybe consider setting up trailing stop losses if the momentum seems to be running a little out of control and hang on for the ride.

Thanks again for dropping by. I hope 2014 turns out to be a great investment year for you all.