10 best-performing shares: Super Stock or Momentum Trap

As the market takes a summer breather, Stockopedia's Ben Hobson has put together a screen of best performing shares and given an investment profile for each one.

July and August are traditionally quiet months in the stockmarket. After a rollercoaster first half, the main indices are trading broadly flat in 2018, but Brexit uncertainty is looming large. So, it's understandable why many of us might feel like heading to the beach for a break.

But as markets drift through the summer months, there are still risks to beware of. Behavioural biases that lead us to trade instinctively can rear up when markets are quiet. In particular, the temptation to take action and trade "just to make something happen" is something worth avoiding.

Here's an illustration of why that is, which was originally described by the excellent analyst James Montier:

Imagine you’re a goalkeeper facing a penalty kick. As the striker hits the ball, is it best to dive left, right or stay in the centre? In research, goalkeepers have been found to dive one way or the other a massive 94% of the time. Yet the optimal strategy is to remain unmoved in the middle of the goal.

So why do goalkeepers tend to dive one way or the other? The answer is that faced with a likelihood of conceding a goal, their instinct is to be seen to be doing something to stop it. If the ball flies into the top left or right corner, they’d surely be berated for remaining unmoved. But if they dive the wrong way… well, at least their intentions were good.

This is called action bias, and it manifests itself in different ways. It could be changing queues at a supermarket checkout, taking an alternative route on a congested road or trading shares absent-mindedly. This instinctive desire to take action gives us a sense of control, yet the outcome is likely to be the same or very possibly worse. 

When it comes to investing, action bias usually leads to over-trading, which drags on investment profits because it racks up lots of extra costs.

Research back in 2000 by the behavioural finance professors Brad Barber and Terrance Odean, found that individual investors pay a "tremendous performance penalty" for active trading. Their analysis of accounts at a large American discount stockbroker between 1991 to 1996, found that those trading the most earned an 11.4% annual return, while the market returned 17.9%. 

They found that a massive part of the problem was that the average portfolio saw a 75% annual turnover. And it was the spreads and commission fees on those trades that proved to be devastating.

While transaction costs have fallen dramatically since the mid-nineties, spreads and commissions are still a major drag on returns, so they need to be minimised.

The answer to action bias is patience - something that requires a great deal of self-control. But in James Montier's words:

 "patience is a weapon you can use to stop yourself becoming an ADHD investor."

Reflections on the past year

So as the market takes a summer breather, we've put together a stock screen looking at some of the best performing shares over the past 12 months. While the market is barely ahead of where it started in 2018, some stocks are continuing to soar.

Using our algorithms for scoring and ranking stocks based on Quality, Value and Momentum, we create a StockRank Style profile for each one. Some are positive and some are potentially negative - but they offer a view of the investment profile for each one, including:

●    Super Stock - positive exposure to appealing value, positive quality and strong momentum.
●    High Flyer - positive exposure to quality and momentum, but high valuation.
●    Turnaround - positive exposure to attractive value and momentum, but low quality.
●    Momentum Trap - strong momentum but poor quality and value.

Source: Stockopedia            Past performance is not a guide to future performance

The results are a really mixed bag. The strongest performing stocks across the FTSE 350 and Small Cap indices come from a broad range of sectors and have very divergent market caps.

The interesting thing about this kind of screening approach is that it shows how the strong run in each of the shares in the list has influenced its investment profile. In most cases, the profiles have remained positive, with the stocks combining strong momentum with either appealing value or quality. But in some instances - as with Ocado Group and Oxford BioMedica - strong momentum isn’t matched by attractive value or quality, which means they could be at risk if the momentum falters.

So, as the stockmarket drifts through summer, it's worth remembering the costly risks of trading instinctively. Across the spectrum - from buy-and-hold to regular trading - action bias is a risk everywhere. As soon as an investor has veered away from a preset strategy, then emotions have taken control. At that point, there is arguably a much higher chance that investment returns can be wrecked by poor, instinctive decision making and over-trading. Regardless of the strategy, patience is crucial.

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