Stockopedia: 10 fast-moving mid-caps leading the market

Spotting stocks with both quality and momentum during periods of uncertainty.

Quality and momentum are two of the most influential drivers of stock market profits - and they’ve played a key role in powering some of the best performances in UK shares over the past year.

Twelve months on from the Covid-inspired market crash, the UK’s FTSE-All Share is continuing its slow return to pre-crisis levels. But behind the scenes some shares have performed exceptionally well.

Against the backdrop of a shaky economic outlook, a challenge for investors is to understand the styles of stocks with the potential to outperform. A blend of quality and momentum has been one way of starting that search - but what does that really mean in practice?

Well, in a nutshell, a strategy that combines quality and momentum looks for high quality, profitable companies with solid finances that are on an upward trend in terms of both earnings acceleration and share price momentum.

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Two powerful factors

When it comes to quality, there are numerous hurdles that different investors insist on. The classic Warren Buffett-style of investing looks for clues in company finances that point to sustainable profitability. Features like high long-term average sales growth, wide margins and returns on capital employed can be helpful.

Terry Smith, the fund manager, is well known for his focus on quality, which he often applies in the Buffett style. He insists on focusing on the strength of a business. So even when the share prices of these companies become relatively high, he can point to the fact that it doesn’t matter if they are fundamentally a lot better than the average company in the market.

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When it comes to momentum, again there are various measures that can be considered.  Companies that are beating forecasts or pulling earnings surprises tend to be those with strong earnings momentum. But momentum in prices - the observation that recent trends tend to persist - is also important. Stocks in an uptrend and performing ahead of the market can be much more appealing than those that are languishing.

In the current conditions, price momentum is a natural first clue in recognising which companies have been badly affected by the uncertain conditions, and which are flourishing in them.

Screening for quality and momentum

With these ideas in mind, here is our regular list of some of the UK’s top-ranking quality and momentum mid-caps. The QM Rank by Stockopedia calculates and ranks a range of quality and momentum measures to find stocks with the strongest blend.

The results capture a list of stocks that have performed very well over the past year in terms of relative strength - and continue to show strong QM rankings. What you often find is that company quality is an enduring factor - it takes time for quality to improve or deteriorate because you only get financial results periodically.

Momentum, on the other hand, can be much shorter term. But when you get consistently high-quality stocks on a strong momentum run, then the trend can, and often does, persist over the medium term.

Several of these shares - like Focusrite (LSE:TUNE), Treatt (LSE:TET), Volex (LSE:VLX) and XP Power (LSE:XPP)- were once high quality small-caps that have grown and grown. Others, like CMC Markets (LSE:CMCX) and Ferrexpo (LSE:FXPO), have more cyclical drivers that propel them in different conditions - right now, financial trading platforms are surging, and specialist miners are also doing well, which is why these stocks appear.

As is always the case, the risk with high quality and momentum is that it can lead to relatively expensive (and potentially stretched) valuations in shares. When strong momentum shares start to disappoint investors with less-than-sparkling performance figures, their trends can decline quickly. So this blend of factors needs to be watched carefully.

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That said, paying a higher price for good-quality shares with positive trends behind them is a proven strategy of applying two very powerful drivers of returns in the stock market. In periods of uncertainty, it’s a strategy that may point you to positive trends that don’t show up on an index chart.