The ground is currently shifting. Momentum investors are being warned to take precautions as more value-oriented stocks seem to be taking control of investor sentiment.
JPMorgan U.S. Equity Strategist Dubravko Lakos-Bujas recently told clients in a note, “It is prudent for investors to avoid exposure to pure momentum stocks (at any price) and we advocate rotating into more reasonable valuation (i.e., momentum at reasonable price).”
Should you abandon momentum stocks entirely?
Well, perhaps not entirely, but you should be much more selective in the momentum stocks you seek to own. Dubravko Lakos-Bujas and his team also noted to clients that value stocks have been punished by investors over the last two years, while momentum stocks have gotten all the love.
While that’s about to change, here are three momentum stocks from the iShares MSCI USA Momentum Factor Index that can survive the momentum crash.
Momentum Stocks With Durability: McDonald’s Corporation (MCD)
McDonald’s Corporation (MCD) is on a tear in 2016; its stock is up 8% year-to-date through April 13, 561 basis points better than the S&P 500. Interestingly, its 3-year annualized return is 9.7%, 203 basis points lower than the index.
What’s so interesting about its underperformance over the past three years?
The MSCI USA Momentum Index methodology involves a bunch of calculations mere mortals don’t want to ever perform. However, the bottom line is that once these are done, it comes up with 100 to 350 stocks for inclusion in the index. For a stock to be included it needs good risk-adjusted returns over the past six to 12 months; the annualized standard deviation used for this calculation is based on a stock’s weekly returns over the past three years.
So, forgetting for a moment that Mcdonald’s stock is up 30% over last year and its momentum is good, the fact remains it underperformed in the two previous years which are considered in the overall stock selection methodology for the index.
Translation: If I had to bet my life, I’d be more likely to err on the side of momentum than with those analysts who are skeptical that McDonald’s has regained its mojo after almost two years of declining quarterly same-store sales.
Yes, McDonald’s needs to do a better job creating a healthier menu — its kale sale has more calories than a Double Big Mac — but skeptics thought it couldn’t get all-day breakfast right, and that’s been a big part of its current resurgence.
McDonald’s momentum is in the bag.
Momentum Stocks With Durability: Facebook Inc (FB)
The number one holding in the iShares MSCI USA Momentum Factor Index is none other than Facebook Inc (FB), one of the world’s biggest tech companies by market cap, and a big believer in a connected world, something Donald Trump’s isolationist policies don’t jive with.
FB stock is also having a good year up 5.6% year-to-date and 33% over the past 52 weeks through April 13.
On two occasions in February, I highlighted the reasons why investors should be clamoring for its stock — my first argument centered around FB being the best of the “FANG” stocks and a few days later I talked about why FB stock was the smartest way to play social media — despite the fact I’m really not a fan of tech stocks.
The bottom line is that the company itself (let’s forget about the stock for a moment) is currently performing at a really high level of execution. Facebook’s free cash flow in the last 12 months was $6.1 billion or 34% of sales, almost double that of McDonald’s, whom I can consider to also be a very good company.
If anyone can keep it going — FB stock is working on a fourth straight year of growth — I have to believe it’s Zuckerberg and company.
Momentum Stocks With Durability: Altria Group Inc (MO)
My third selection has free cash flow that’s almost as impressive as Facebook. Altria Group Inc (MO) generated $5.6 billion in free cash flow in 2015, a 24% increase year-over-year, and 29.6% of revenue.
Any way you slice it that’s good for shareholders. However, the question we’re addressing here isn’t whether it’s doing right by shareholders, but rather if its momentum can continue.
MO stock is up 8.6% year-to-date through April 13. Farther out, it’s up 24.2%, 23.8% and 21.8% over the last one-, three- and five-years, respectively. Just 4% off a 5-year and all-time high of $64.16, it’s riding an eight-year winning streak.
If any stock is ready for a momentum crash, MO would have to be considered a leading contender … wouldn’t it?
One would think so. However, yield continues to be a hard thing to come by; thus, MO’s current 3.6% payout continues to be attractive. What investors lose on yield due to its stock endlessly moving higher, they gain in capital appreciation. Over the long-term that’s a winning recipe.
Once the beer merger between Anheuser Busch Inbev SA (ADR) (BUD) and SABMiller plc (ADR) (SBMRY) is completed, MO will get $2.5 billion in cash, 10.5% ownership in the combined business and plenty of future dividends.
This is a cash-generating machine and even though it’s trading at a historically high valuation, its ability to continue spinning cash outweighs investor concerns about price.
MO continues its momentum higher.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.