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Phil Dabo: Welcome to Quant Concepts' working from home edition. We've seen price momentum perform quite well recently with companies such as AcuityAds generating an outstanding 2,100% return over the past year. Although momentum strategies may exhibit higher turnover and significantly higher volatility, they can still provide huge returns as well.
Today, let's take a look at a price momentum strategy that has had significant outperformance over the past year and over longer periods of time.
Now, let's start by selecting our universe of stocks. Today, we're going to select all of the Canadian stocks with the complete data set in our CPMS universe. We're going to rank those stocks from 1 to 700 according to three simple factors. These are all short-term price momentum factors. The first is the price change over the past three months. The second is the price change over the past six months. And the third is the price change over the past nine months.
Once we have our stocks ranked from 1 to 700, we're going to start screening for the stocks that we want. Here, our buy rules are very simple. We're only going to buy stocks that are ranked in the top 15th percentile of our list. We're only going to buy stocks that rank in the top third based on the price change to 12 months high. This is a good price momentum variable that also performs well during down markets. The idea is that stocks trading close to their previous 12-month high tend to continue doing well. The last buy rule is the Morningstar quantitative health score. This is a proprietary measure indicating a company's financial health based on the firm's leverage. A higher score indicates lower leverage and less likelihood that the company will fall into financial distress. The minimum score of 2 will prevent the model from buying stocks with the worst financial health.
Now, let's take a look at our sell rules. Again, our sell rules are very simple. We're going to sell stocks that fall to the bottom 50th percentile of our list. We are going to sell stocks if their financial health deteriorates and drops below two-thirds of our list based on the Morningstar quantitative financial health score.
Now, let's take a look at performance. The benchmark that we used is the S&P/TSX Total Return Index, and we tested this strategy from January 2005 to February 2021. Over this time period, this strategy has generated an outstanding return of 20.8%, which is 13.5% higher than the benchmark, and it also has 107% annualized turnover, which is expected from a price momentum strategy.
When looking at performance, we can see that this strategy has outperformed the benchmark over every significant time period, and it's done so with an outstanding one-year return of almost 112%. As expected, this strategy has slightly higher price risk as measured by the standard deviation, but it also comes with a higher risk-adjusted return as measured by the Sharpe Ratio. Also, as expected, this strategy has higher market risk as measured by beta.
When looking at this chart, we can see outstanding performance over time, especially over the past year. And when looking at the market capture ratios, we can see that this is a strategy that performs quite well in up markets which contributes very nicely to the overall market capture ratio. This is a great strategy to consider if you're looking for companies that have strong price momentum and if you're comfortable with higher volatility. It's also important to note that this is a higher turnover strategy where timing the market can have a greater impact on returns.
The buy list can also provide some great stock ideas for investors looking for a short-term return. You can find the buy list along with the transcript of this video.
From Morningstar, I'm Phil Dabo.
For a large image of the buy list, click here.
