Gain The Most From Momentum Stocks

Gain The Most From Momentum Stocks

The market is gaining momentum while the broader markets are participating in a healthy way. Geyatee Deshpande explains why it is a good idea to bet on momentum stocks while Vinayak Gangule recommends the momentum stocks you can bank on

Momentum stocks are always in fashion be it a bull market phase or a recovery phase in the markets. Momentum stocks are popular because they have the potential to beat the benchmark index and the price rise is often swift in momentum stocks. Simply put, momentum stocks are those that have shown an increase in price over the previous 3-6 months. Momentum investing works on the philosophy that winners keep on winning and losers keep on losing at least in the near to mid-term.

The idea of buying based on price strength and selling based on price weakness is at the core of momentum investing. Apart from several momentum indicators that can be used to identify momentum stocks, one of the best ways to gauge the momentum in stocks and in the broader markets is to check the 52-week high levels across the market. Any stock touching its 52-week high is an indication of the underlying bullishness in the stock. The 52-week highs reflect the price strength that any momentum investor may be looking for.

Market Indicators 

If we consider stocks that are hitting their 52-week highs in July, we find that almost 351 stocks on the BSE touched their respective 52-week highs that saw the Sensex gain 5 per cent in the first 10 days of July. In the pre-pandemic period or the month just before the lockdown i.e. February, almost 380 stocks touched their respective 52-week highs while January saw 438 stocks listed on the BSE hit their respective 52-week highs. The lockdown period of April saw 77 stocks, May saw 62 stocks and June saw 280 stocks touching their respective 52-week highs.

This goes to show participation is increasing as recovery is getting priced in and an increasing number of stocks are touching their respective 52-week highs. The broader market participation reflects the strength of the current rally and doubters in the current market rally and strength can relook at the broader market participation that suggests the health of the rally. Many would argue that penny stocks and low liquid stocks are also showing momentum but these stocks may not qualify as ‘good investments’ as the risks are considerably high while investing in such low liquid and penny stocks.

Investor can thus focus on BSE 500 index constituents and peruse those stocks that are showing relative price strength. By focusing on BSE 500 constituents, investors will be focusing on liquid scrips with relatively good fundamentals. As can be seen in the table alongside, as many as 31 stocks out of 500 stocks have touched their respective 52-week highs as on July 10. The momentum is picking up and more and more stocks are seen touching their respective 52-week highs. This is a healthy sign for investors.

Momentum Strategy

There has always been a debate amongst market participants on which strategy is superior and can beat the key benchmark index consistently. A huge percentage of market participants believe it is value investing that can help beat the markets while another breed of investors believes in adopting momentum strategy to beat the key benchmark index i.e. the Sensex. Is it so simple that by adopting a momentum strategy you can beat the Sensex returns, that also on a consistent basis? It does seem so! If we look at the historical performance of BSE Momentum index versus BSE Sensex, clearly the outperformance of the BSE Momentum index is catchy, to say the least.

The best part of the momentum investing strategy is that it has consistently beaten the Sensex returns. The below table reiterates this fact and highlights the outperformance of the BSE Momentum index over the Sensex. The average return generated by the BSE Momentum index is around 11 per cent over the past four and half years starting 2016 as compared to that of the Sensex that stands at around 7.77 per cent. There is a clear outperformance of almost 3.33 per cent per annum. The outperformance is good enough to be taken note of by the investing community.

In a momentum investing strategy, it is important to ride the positive curve as long as possible. 

The most interesting aspect about the BSE Momentum index has been that the YTD returns have been negative 8 per cent while the Sensex has dropped by 11.29 per cent on YTD basis. Usually, market correction phases tend to batter momentum stocks, thus leading to underperformance. This goes to show that momentum stocks can outperform the benchmark index or beat the markets if the momentum stocks are combined with fundamentals. Including momentum stocks that are fundamentally poor could be hazardous to one’s portfolio; however, when relative price strength is seen in fundamentally good stocks, these stocks should be preferred as beating markets would be easy using these stocks. Note, however, that only in the year 2018 has the momentum strategy failed to beat the Sensex while in all the other years the strategy has beaten the Sensex easily.

Identifying Momentum Stocks

While a large number of investors are convinced about the possible gains by adopting momentum investing strategies, many investors struggle to identify quality momentum stocks. The following pointers should help guide momentum investors identify quality momentum stocks.

Earnings Acceleration : The trick is to identify those companies which are showing or expected to show acceleration or momentum in earnings. Chances are very good that the stock price rise is steep in cases where the earnings’ acceleration or earnings’ momentum is seen.

Analyst Revisions : It is often observed in the markets that whenever a leading broker revises the earnings’ growth and the upside target, the stocks start showing traction as participation increases in that particular counter. It becomes important for the momentum investor to track the analyst’s recommendations, the earnings upgrades and increase in price targets for the stocks. It will help the momentum investor to enter the investment early, thus creating an opportunity to book impressive profits.

Technical Indicators and Price Volume Breakouts: Momentum investing can be best explored by using certain technical indicators. In practice, there are very many indicators that can be applied; however, a chartist always has a few favourite technical indicators which he or she has mastered. These carefully chosen technical indicators along with price volume breakouts in stocks can be used to buy momentum stocks. Volume analysis is the key in momentum investing so that investors are not stuck with a false momentum signal. Usually the price breakout with huge volumes is considered healthy and reflects the strength in price momentum.

Improving Valuations : Whenever investors find that there is improvement in the overall valuations of the company, chances are that the company’s stock price will start rising, beating the benchmark indices or even the broader markets. The best example in front of us right now is that of Reliance Industries Limited (RIL). The stock saw a massive re-rating and the value got unlocked due to Reliance Jio. The overall valuation improved for the stock, thus making it a perfect candidate for momentum investing.

Conclusion

There is a saying that when it comes to an equity investing strategy, any single strategy that is guaranteed to deliver profits and known to all is doomed to fail in the long term. In other words, there is no single strategy that has worked for all investors. Momentum investing strategy, however, remains an exception. Across various asset classes and geographies, momentum investing has proven to be a profitable and market-beating strategy. That said, momentum investing is not for the fainthearted and requires constant monitoring of portfolio or at least higher monitoring when compared to value investing.

Once the risks of momentum investing are known and well-calculated, the strategy can be best explored using various methods such as technical analysis, earnings momentum, etc. to beat the markets consistently. Yes, in certain years the drawdown could be huge for those adopting the momentum strategy but in the longer run momentum investing strategy stands out and has proven to be beating the broader markets quite comfortably. Investors have to constantly check if the momentum is fizzling out. Change in market moods and change in market leadership need to be ascertained for optimal results while adopting a momentum investing strategy.

It is quite possible that small-caps and mid-caps are the flavour of the season and as a momentum investor you may construct a portfolio primarily including small-caps and mid-caps. However, the market flavour changes as it did in 2018 when suddenly the small-caps and mid-caps were out of favour owing to the SEBI directives issued to mutual fund companies, limiting their holdings of small-caps and mid-caps. Large-caps started showing momentum for a good two years post such a shift in the market trend.

As a momentum investor, it is imperative to switch from small-caps and mid-caps to large-caps simply because the momentum has changed from broader markets to select large-caps. Also, whenever the markets correct, the next market rally throws up new market leaders. It is not always that banks have to lead the market recovery phase and consequent market rallies. The leadership could come from IT, FMCG or automotive stocks. As a momentum investor, efforts need to be concentrated on identifying the emerging market leaders. This exercise, if executed well, can reap abnormal profits in the near to medium-term and eventually beef up the long-term performance.

Momentum investing produces best results in a bullish market setup and also in the market recovery setup. The results could be disturbing during market correction phases for those who are stuck with momentum stocks. For best portfolio results, investors can construct a diversified portfolio of momentum stocks that are fundamentally strong with quality balancesheets and earnings’ growth in place. In simple words, adopt a momentum investing strategy where investors buy only those stocks which have shown a price rise in the past three to six months.

Stocks that show momentum in a price rise are fundamentally strong. This exercise may limit the downside in the portfolio even when things go wrong i.e. when the market undergoes correction. Right now, when the global markets are in a recovery phase and the momentum in stocks is strong, it could be an ideal time to pick up momentum stocks albeit with the realisation that market correction is always a possibility. We have handpicked a couple of momentum stocks that may add value to your portfolio.

Stock Recommendations

In the category of momentum stocks, we are recommending herewith two stocks that have the potential for quick growth and gains:

Fine Organic Industries CMP (Rs ) : 2068.30 

BSE Code : 541557 I Face Value (Rs ) : 5 I Mcap FF (Cr.) : 1,585.35 I 52 Week High / Low : Rs 2,548.30 / 1,350.00

Fine Organic Industries Limited manufactures oleochemical-based additives for food, plastic, cosmetics, paint, ink and coatings. The company sells its products under the brand ‘Fine Organics’. Its products include Datem, Acetem and Lactem. It primarily manufactures three types of food additives: anti-fungal agents and preservatives, emulsifiers and other specialty additives. It manufactures a range of plastic additives such as polyolefins additives, styrenics, elastomer and thermoplastic elastomer compound additives, engineering plastic processing additives, foamed plastic product additives, polyvinyl chloride processing additives and thermosets or composite product additives. The company is also involved in the manufacturing of cosmetic and pharmaceutical additives and rubber additives. It produces anti-settling agents, thickening and anti-sagging agents, wetting and dispersing agents, defoamers, biocides and anti-mar waxes. Its subsidiaries include Fine Organics USA Inc. and Fine Organics Europe BVBA.

On the consolidated financial front, the net sales for the fourth quarter of FY20 amounted to Rs 247.28 crore – a decrease of 13.02 per cent as compared to net sales of Rs 284.28 crore for the fourth quarter of FY19. The decrease in sales figures for Q4FY20 can be attributed to the loss of sales during the last two weeks of March led by the virus pandemic and also on account of the logistic problems faced domestically as well as in many other countries.

The PBDT for fourth quarter of FY20 was reported to be Rs 60.33 crore, which is an increase of 0.62 per cent as compared to Rs 59.96 crore reported for the same quarter of the previous fiscal year. The company’s net profit gained in Q4FY20 rose by 28.19 per cent to Rs 35.26 crore from the net profit of Rs 27.51 crore gained in the fourth quarter of FY19 as a result of higher other income and lower tax rate.

Looking at the annual trend, net sales were reported to be Rs 1,038.08 crore for FY20, thus decreasing by 2.1 per cent when compared to Rs 1,060.33 crore for FY19. In FY20, PBDT increased by 1.69 per cent to Rs 255.84 crore from Rs 251.58 crore reported for FY19. The company calculated the net profit for FY20 at Rs 169.86 crore, rising by 21.67 per cent compared to net profit of Rs 139.61 crore gained in FY19.

During the year, a favourable product mix resulted in achieving higher margins. Meanwhile, the short-term revenue outlook remains a bit uncertain as the company’s management expects that pre-pandemic operational level would be achievable only post Q2FY20 since the speed of recovery in the existing business environment is still comparatively slow and quite challenging. An increase in demand in the additive industry has allowed for the company to undertake capacity expansions which could further lead to volume growth.

The company is expanding its capacity by 42,000 MTPA out of which 32,000 MTPA is in its Ambernath plant dedicated for plastic, rubber and cosmetic additives. This plant was commissioned in Q2FY20. It will provide the company with opportunities for revenue growth. Going forward, a strong balance-sheet and volume growth backed by capacity expansions, growing demand for green additives from the food industry, changing customer preferences and better business mix will strengthen the company’s growth trend. Hence, we recommend the option of BUY.

RPG Life Sciences Limited CMP (Rs ) : 288.05

BSE Code : 532983 I Face Value (Rs ) : 8 I Mcap FF (Cr.) :157.21 I 52 Week High / Low : Rs 351.00 / 146.00

RPG Life Sciences Limited develops, manufactures and markets branded drugs, bulk drugs and generics. It operates through four business units, which include APIs, global generics, global formulation and biotech. The API product line offers a range of synthetic APIs in the general therapeutic category to Europe, Latin America, Asia and the United States markets. Its global generics business unit commercializes finished dosage forms in markets such as North America, the European Union and Australia. The global formulation product line of the company manufactures and markets finished dosage formulation in domestic and other markets. In the biotechnology space it offers oncology products through the fermentation route. Its portfolio of products includes tablets such as Anastrazole, Exemestane, Lamotrigine and Azathioprine.

On a standalone quarterly front, net sales reported by the company grew impressively by 28.88 per cent in Q4FY20 to Rs 88.67 crore from Rs 68.80 crore in the same quarter for the previous fiscal year. Operating profit in the quarter ended March 2020 surged by 84.79 per cent to Rs 12.88 crore from Rs 6.97 crore in the quarter ended March 2019. The net profit reported by the company was Rs 2.98 crore in Q4FY20, expanding by 93.51 per cent from Rs 1.54 crore in the corresponding quarter for the previous fiscal year. The company’s EBITDA margins improved from 10.1 per cent in Q4FY19 to 14.5 per cent in Q4FY20.

Looking at the annual trends, the company reported net sales of Rs 375.57 crore in FY20, growing by 13.75 per cent from Rs 330.16 crore in the previous fiscal year. Operating profit reported for the fiscal year ended March 2020 came in at Rs 59.88 crore, increasing by 74.27 per cent from Rs 34.36 crore recorded in the fiscal year ended March 2019. Net profit grew substantially to Rs 29.01 crore in FY20 from Rs 10.81 crore in FY19, showcasing an impressive growth rate of 168.36 per cent.

The Indian medical device and pharmaceutical sectors have witnessed a disruption in their supply chain due to the virus pandemic scenario, particularly due to the temporary suspension of raw materials and Class 1 medical devices from China. This has resulted in the Indian government strongly focusing on building India’s capability in the healthcare, pharmaceutical and bulk chemicals sector to reduce import dependency. The long-term prospects of the industry thus look positive with the government’s focus on increasing mass access to healthcare.

Overall, RPG Life Sciences recorded fairly consistent sales and profit performance for all four quarters this year and has been largely unaffected on the financial front due to the disruptions caused by the pandemic and resulting lockdown. For the fiscal year ended March 2020, the company registered a turnaround performance led by its biggest contributing domestic business, which grew over 23 per cent, much ahead of the market growth. The company’s rejuvenated product portfolio, its focus on the prescription generation and sales force effectiveness are likely to be the key contributors driving growth in revenues in the quarters ahead. We recommend our investor readers to BUY this scrip.
(Closing price as of July 15, 2020)

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