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Four "momentum" investment tactics

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06/18/2019 | 02:59pm EDT

Many long-term investors cultivate a certain snobbism against more speculative investment tactics, something that sometimes works against them. Traditionally, they are more faithful to the so-called ‘buy and hold’ methods which are well inspired and not to be questioned here.

And while it’s only natural to preach for your own parish, there’s nothing wrong with borrowing a different method from your neighbour every once in a while and to have more than one string to your bow. It’s in this spirit that we’ll discuss four very useful indicators common to ‘momentum’ strategies in case you want to optimize your portfolio management.

First: the company has just refinanced its debt on favorable terms. This kind of event often leads to an immediate revaluation of the share price because the financial basis is sanatized and the risk of bankruptcy is eliminated - or postponed in the most critical cases.

To increase the efficiency of this tactic, use it when the assessed company is small in size - i.e. not on the radar of institutional investors - and has a modest debt level; the market won’t be fooled if the company is buried under its financial obligations and only gets some temporary relief via this refinancing opreation.

Secondly: the Board of Directors has just approved a massive share buyback plan. A decision of this nature is usually made when the company's shareholders consider its value to be much lower than its intrinsic value; on paper, therefore, it is a rational and opportunistic investment.

This sword, however, is double-edged. On the one hand, if the discount is real and the company’s future prospects are good, the transaction will probably prove to be very profitable for the shareholders, as the company's net assets will grow while the number of shares - the parts of the cake - will decrease, which will automatically increase the value per share.

On the other hand, it is necessary to ensure that the company’s management does not consume its cash flows or precious reserves to buy back its shares at high valuations - at the risk of the investment producing an anaemic or negative return. It’s important to make sure that such a choice is not motivated by the wrong reasons, such as an excessively high compensation plan focused on the net profit per share.

To increase the efficiency of this tactic, favour reduced stock floats here - because share buybacks will then have an actual impact - and companies that are used to communicating with prudent investors. From experience, we know that share buybacks are often less sensible when they are set up by companies that are used to overly optimistic announcements.

Thirdly: the "insiders" - i. e. influential managers and shareholders - buy shares themselves on the market. Because these operations must be reported to the supervisory authorities, these transactions are easy to track and follow in real time.

Apart from a few exceptions, the company’s managers of course know more about the company's situation and prospects than outside observers, even if the latter are competent and diligent. As such, if said managers devote a significant part of their personal assets to purchase shares, this is without a doubt for a good reason.

Fourth: the sector in which the company operates is consolidating. Ideally, the company is being forced to act by dominant and well-capitalised companies, as we are seeing for instance in the electronic payment industry these days.

Whenever there is a frenzy of M&A transactions and when the dominant players find themselves in a race to dominate the market, the takeover bids made to intermediate players are often juicy - or sometimes just completely unreasonable, but that is another story.

Focus on mid-sized companies here since large companies will prefer medium to small ones - with a satisfying growth history. Also, familiarize yourself with EV/EBITDA-type valuation ratios rather than the traditional consolidated profit multiples that make less sense for the acquiring party which is primarily focused on the target's profitability before interest and taxes.

In a different context, but with the same objective of combining "fundamental" and "momentum" investment strategies, Surperformance - the publishing company behind MarketScreener - has developed a powerful, exhaustive, and automated data aggregation technology. The management of our portfolios is entirely based on this technology.

Neelie Verlinden
© MarketScreener.com 2019
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