Follow Driehaus’ Rule & Pick These 5 Momentum Stocks

Zacks

Investors with a high risk appetite always look for a momentum strategy that can add to their portfolio returns. Momentum investing seeks to fulfill their objectives through the principle of "buying high and selling higher." Richard Driehaus, who is considered as one of the pioneers in this domain, built a portfolio by following the philosophy and the same succeeded in yielding robust returns. This success earned him several honors from the investment world. Barron honored him by including his name in its All-Century Team, which also includes famous investors such as Peter Lynch and Bill Miller.

Separately, famous investing institutions such as the American Association of Individual Investors (AAII) found that Driehaus’ momentum strategy has the potential to offer healthy returns. According to AAII, the strategy generated returns of 13.5% and 18.1% in the five- and 10- year timeframe, respectively, against -1.1% and 4.2% returns registered by the S&P 500. Hence, one may apply Driehaus’ momentum strategy to build a profitable portfolio.

The Strategy

After studying Driehaus’ strategy thoroughly, AAII came to the conclusion that companies with impressive earnings growth rates and the potential to maintain the positive trend are its main focus. In addition to that, Driehaus gave precedence to those companies that have a solid track of beating expectations. Moreover, the strategy works better for longer time periods.

Driehaus had said in an interview: “That means buying stocks that have already had good moves and have high relative strength – that is, stocks in demand by other investors. I would much rather invest in a stock that’s increasing in price and take the risk that it may begin to decline than invest in a stock that’s already in a decline and try to guess when it will turn around.”

How to Apply the Strategy

Based on Driehaus’ approach, we have created a screen for picking solid momentum stocks. In it, we have added positive relative strength as an important criterion. Then, we have followed it up with the percentage 50-day moving average, which is calculated by dividing the numerator (month-end price minus 50-day moving average of month-end price by the 50-day moving average of month-end price). Positive percentage 50-day moving average indicates that the stock is trading at a price higher than its 50-day moving average level, indicating an uptrend.

In order to make the strategy more profitable, we have only considered those stocks with a Zacks Rank #1 (Strong Buy) as well as a momentum score of ‘A’. Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or #2 (Buy) offer the best upside potential.

• Zacks Rank equal to #1
(Only Strong Buy rated stocks can get through. You can see the complete list of today’s Zacks #1 Rank stocks here.)

Last 5-year average EPS growth rates above 2%
(Strong EPS growth history ensures improving business.)

Trailing 12 month EPS growth higher than 0 and industry median
(Higher EPS growth compared to the industry average indicates superior stocks.)

Last four-quarter average EPS surprise greater than 5%
(Positive EPS surprise indicates potential.)

Positive % 50-day moving average and relative strength over 4 weeks
(High % 50-day moving average and relative strength signal uptrend.)

Momentum Score equal to A

Just these few criteria narrowed down the universe of over 7,700 stocks to only 14.

Here are five of the 14 stocks:

Activision Blizzard, Inc. ATVI is a worldwide pure-play online and console game publisher with leading market positions. Activision Blizzard has an average four-quarter positive earnings surprise of 33.5%.

Gibraltar Industries, Inc. ROCK is a leading manufacturer, processor, and distributor of metals and other engineered materials for the building products, vehicular, and other industrial markets. Gibraltar Industries has an average four-quarter positive earnings surprise of 67.3%.

Northrop Grumman Corporation NOC is a high technology company providing innovative solutions in systems integration, defense electronics and information technology. Northrop Grumman has an average four-quarter positive earnings surprise of 8.3%.

SJW Corp. SJW is a public utility in the business of providing water service to a population of approximately 928,000 people. SJW has an average four-quarter positive earnings surprise of 78.5%.

SPS Commerce, Inc. SPSC is a provider of on-demand supply chain management solutions, providing integration, collaboration, connectivity, visibility and data analytics to its customers worldwide. SPSC has an average four-quarter positive earnings surprise of 44.2%.

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.

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