Market timing can be one of the most important aspects to consider when investing. “Buy low, sell high” is widely considered as the most simple rule to investing. But, should investors really buy shares that are trading near their historical lows, and then sell them when they are near their historical highs?
Over a century of empirical evidence suggests that this method of choosing shares is ill-conceived. Buying shares that are trading near their historical lows often leads to poor investment returns. Shares that have outperformed the market, or are trading near their historical highs, tend to also outperform poorly performing shares in the following months. This phenomenon is known as the “momentum effect”.
Although analysts are not entirely certain for why the momentum effect exists, there are many possible explanations. One reason could be that investors may have systemic upward biases for the earnings forecasts of underperforming shares, leading to a cycle of earnings disappointment and lower share prices. Another could be crowd behaviour, where fund managers follow one another to create a similar portfolio of assets, causing share prices to exhibit momentum.
“Buy high, sell higher” is the adage that investors would do well to remember. And here are attractive five momentum shares:
Shares in Shire (LSE: SHP) have risen 50% over the past year, and the company has a forward P/E of 21.1. The company has gone on an acquisition spree in recent years to bolster its pipeline of new treatments for rare diseases. Currently, Shire is looking at buying Actelion, a Swiss biotech firm, for a reported £12.4 billion.
Shire’s strong pipeline of new treatments for rare diseases should help it to deliver faster earnings growth than its big pharma rivals, including GlaxoSmithKline and AstraZeneca.
ITV (LSE: ITV) has been showing strong earnings momentum in recent years, with adjusted earnings having risen by 75% over the past four years. The company has recovered strongly since the recession, and is successfully growing its online, pay and interactive offerings, which saw revenues grow 30% in 2014. Its forward P/E is 17.0.
Shares in Sirius Minerals (LSE: SXX) have risen by 79% over the past year, as the prospects of obtaining the necessary permits for its Yorkshire potash mining development seem increasingly promising. The prospective cost of production is expected to be as low as $30 per tonne, which compares favourably to the market price of potash of over $200 per tonne.
But, the company still needs to source more than £1.5 billion to fund development costs, when the project is finally approved. Investors will have a long wait before the company begins to return cash to shareholders.
Although Betfair (LSE: BET) is better known for its betting exchange, its bookmaking business is doing much better in attracting new customers. The company has invested strongly in developing a competitive edge through product innovations, including in-game cash outs and “price rush”.
The bookmaker is set to announce its preliminary full year earnings on Wednesday 17 June. Currently, analysts expect adjusted earnings per share of 74.2 pence, with revenues of $471 million. This implies a forward P/E of 33.8.
Oxford BioMedica (LSE: OXB) is attractive because of its development collaboration deal with Novartis. Significant development revenues from Novartis could transform the company to become operationally cash flow positive by 2016. The company’s pipeline of gene and cell therapies are in the early stages of development, so investors in Oxford BioMedica may have a long wait.
Momentum investing is not for everyone
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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended shares in GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.