10 top stocks with the wind in their sails

Momentum can be a great investment strategy, but is risky. Stockopedia's Ben Hobson screens the market for high-quality businesses which fit the profile of potential high flyers.

Shares in life sciences company Abcam fell by 15% when it published its full year results this week. In fact, at one point during the day, its price was down by more than 30%.

For random observers, who may not have even heard of Abcam, the cause of this savage drop might have looked obvious - the antibody specialist must have undershot expectations. But that wasn't the case at all. Abcam's results were in line with forecasts. Revenues were up, targets were hit and even the dividend was hiked by 18%. So why did the price tumble?

The answer was that Abcam said it was planning to invest more in research, development and expansion. Inevitably that would put pressure on earnings in the coming years, and it was this that rattled the market. 

It's quite common for investors to be left bemused when share prices fall on seemingly good financial results. The causes can be wide and varied, but Abcam is an interesting case. With a market cap now of £2.7 billion, it's one of the largest companies quoted on the Alternative Investment Market (AIM). It's also one of the most profitable. 

In fact, Abcam has an impressive track record of growing profitability, cash generation and efficiency. This has made it very attractive to many investors - which in turn meant it was particularly vulnerable to a stomach-churning price drop, and here's why…

Abcam belonged - and still belongs - to a high-flying group of stocks that share a clear investment profile. They have some eye-catching quality characteristics, meaning they're profitable, often resistant to competition and financially robust. Plus, their strong track records earn them support in the market. Consistent overachievement in earnings growth makes them popular. And that manifests itself in relentless price momentum.

So, stocks like Abcam are appealing for their good quality and strong momentum. But the flipside of the coin is that they can end up looking expensive against regular valuation metrics. But some investors believe that eye-watering prices can be justified if earnings in a company are growing rapidly.

It was that kind of momentum that caused shares in Abcam to rise from £5 to £15 in a little over three years. In that time, its average price-earnings (PE) ratio was well over 20x, and last year it hit 68x. But when the market senses the growth might falter, those kinds of valuations can look stretched. Thereafter, the momentum crash can be swift and startling.

How to handle high flyers

Although severe, the price fall at Abcam only wiped out three months' worth of gains. Holders of the stock will now have to decide whether the company's high-flying growth profile really has changed. 

Some companies can sustain their high quality, strong momentum (but often expensive) investment profiles over many years. Just a few past examples include the likes of Domino's Pizza, JD Sports, Next and Rightmove. These kinds of stocks can compound returns over long periods but they need to be watched carefully. When the investment case changes, their expensive valuations can lead to sudden price reversals.

With that in mind, this week's top 10 takes Stockopedia's quality, value and momentum rankings to pick out stocks which share the profile as potential high flyers.

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

The kinds of stocks passing these rules are often well known to investors. Companies like Craneware, Electrocomponents, Victrex and Burberry are well-followed stocks with reputations for being high quality businesses.

In bullish conditions these types of firms can see their momentum accelerate as investors move into the market. Their quality should, on average, mean that they are less likely to deliver nasty surprises. 

But it's important to know that high flyers will usually falter eventually. Missed expectations, changes in management, strategy or market conditions can unsettle the market. As investors in Abcam found out recently, the impact on share prices can be big. The question then is whether the investment case has genuinely changed or if the market is offering a momentary chance to buy at a slightly lower price. 

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