10 stocks that are leading the market recovery

Investors can profit by finding stocks trading at 52-week highs. Stockopedia's Ben Hobson tells you how.

It might be a bit early to say the market is properly recovering from last year's savage slide, but some stocks are clearly bouncing back. And for others, the market correction last year made barely a dent on their price momentum.

In these conditions an interesting screening strategy to explore is the '52-Week Highs' list. As we've mentioned in this column before, most investors take a passing interest in the stocks that are hitting new highs. This kind of data can be found in newspapers and on financial websites everywhere. After a period of downward pressure, it's a useful gauge of shares that are bouncing back fastest.

What makes the 52-week high such an interesting data point is that there's a lot of psychology behind it. A couple of decades of academic research has shown that ‘new highs' can provoke all sorts of irrational behaviour in investors. 

So whether you're interested in price momentum and new highs or not, just knowing about this irrational behaviour can help you avoid the same mistakes - and perhaps help you profit from them.

What lies behind the 52-week high?

On its own, the 52-week high is a static number. But research has shown that stocks hitting new highs very often drift higher in price over the subsequent weeks and months.

This upward trend is known as "post earnings announcement drift" - an academic name for what happens when investors only slowly buy shares that are already hitting new highs. When new earnings news about that share is published, particularly if it's a positive earnings surprise, the price may well be slow to respond.

This confused reaction is caused by what the psychologists Amos Tversky and Daniel Kahneman called anchoring-and-adjustment. The idea is that humans form an anchor, or a belief, using a reference point (like a share price). As new information comes to light (like new earnings news) they only slowly adjust their beliefs away from that anchor point.

Getting back to investing, the idea of anchoring around events like 52-week highs and earnings surprises is thought to be a big contributor to the ‘momentum effect'. 

In fact, work by academics Thomas George and Chuan-Yang Hwang found that the 52-week high causes irrational pricing behaviour because of anchoring. As that behavioural brake is gradually released, the price drifts higher as momentum takes over.

Follow up research by the same team found that companies trading close to new highs and go on to deliver positive earnings surprises are particularly likely to experience post earnings announcement drift.

Of course, in bearish conditions, when investors suddenly become risk-off and share prices fall across the board, a 52-week high strategy will suffer. You can see on this chart how the market slide last year affected the performance.

Source: interactive investor  Past performance is not a guide to future performance

But when markets start to recover, this screen is the first to show which stocks have withstood the decline and are recovering quickest. 

Here are some of the companies currently trading around their 52-week highs at the moment. We've included the price/earnings (PE) ratios as a valuation indicator, and the QualityRank offers an idea about the business quality and financial health of these stocks. It scores and ranks companies based on a range of profitability, efficiency and safety measures - from zero (poor) to 100 (strong).

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

Leading the 52-week high list right now are two defensive names: Britvic (LSE:BVIC) and Diageo (LSE:DGE). But there's a mixed bag of sectors here, with cyclical stocks like Dunelm (LSE:DNLM), Coats (LSE:COA) and Whitbread (LSE:WTB) in amongst industrials like Experian (LSE:EXPN), RELX (LSE:REL) and Rentokil Initial (LSE:RTO). 

We used a minimum market cap filter of £25 million to remove very speculative names. But even so, it's notable that it's mid and large-cap stocks that are currently setting the pace among those shares that are bouncing back.

Overall, it's worth remembering that while the 52-week high seems like quite a straightforward measure, it's actually got some deep psychology behind it. Investors tend to be wary of bidding up the prices of stocks hitting new highs - but this can actually cause their prices to drift higher over time.

Recognising the likelihood of anchoring in the market - especially as a potential driver of momentum - is useful. Just by knowing that events like 52-week highs can cause irrational pricing means it’s possible to choose to avoid them altogether or use the 'new highs' strategy to take advantage of them.

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