Richard Driehaus, one of the most outspoken proponents of momentum investing, became popular in the 1980s and 1990s due to his successful investment strategy based on the philosophy that "buying high and selling higher" could generate more returns than buying undervalued stocks and selling them high. Banking on the same, Barron honored him by including his name in its All-Century Team, which also includes famous investors such as Peter Lynch and Bill Miller.

Famous investing institutions such as the American Association of Individual Investors (AAII) found that Driehaus’ momentum strategy has the potential to offer healthy returns. According to AAII, the strategy generated returns of 13.5% and 18.1% in the five- and 10- year timeframe, respectively, against -1.1% and 4.2% returns registered by the S&P 500. Hence, one may apply Driehaus’ momentum strategy to build a profitable portfolio.

The Strategy

After studying Driehaus’ strategy thoroughly, AAII came to the conclusion that companies with impressive earnings growth rates and the potential to maintain the positive trend are its main focus. In addition to that, Driehaus gave precedence to those companies that have a solid track of beating expectations. Moreover, the strategy works better for longer time periods.

Driehaus had said in an interview: “That means buying stocks that have already had good moves and have high relative strength – that is, stocks in demand by other investors. I would much rather invest in a stock that’s increasing in price and take the risk that it may begin to decline than invest in a stock that’s already in a decline and try to guess when it will turn around.”

How to Apply the Strategy

Based on Driehaus’ approach, we have created a screen for picking solid momentum stocks. In it, we have added positive relative strength as an important criterion. Then, we have followed it up with the percentage 50-day moving average – which is calculated by dividing the numerator (month-end price minus 50-day moving average of month-end price by the 50-day moving average of month-end price). Positive percentage 50-day moving average indicates that the stock is trading at a price higher than its 50-day moving average level, indicating an uptrend.

In order to make the strategy more profitable, we have only considered those stocks with a Zacks Rank #1 (Strong Buy) as well as momentum score of ‘A’. Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or #2 (Buy) offer the best upside potential.

• Zacks Rank equal to #1
(Only Strong Buy rated stocks can get through.)

• Last 5-year average EPS growth rates above 2%
(Strong EPS growth history ensures improving business.)

• Trailing 12 month EPS growth higher than 0 and industry median
(Higher EPS growth compared to the industry average indicates superior stocks.)

• Last four-quarter average EPS surprise greater than 5
(Positive EPS surprise indicates potential.)

• Positive % 50-day moving average and relative strength over 4 weeks
(High % 50-day moving average and relative strength signal uptrend.)

• Momentum Score equal to A

 Just these few criteria narrowed down the universe of over 7,700 stocks to only 15.

Here are five of the 15 stocks:

Facebook, Inc. operates a social networking website worldwide. The company's products for users are free of charge and available on the Web, mobile Web, and mobile platforms, such as Android and iOS. Facebook has an average four-quarter positive earnings surprise of 18.3%.

PetMed Express, Inc. (PETS Quick QuotePETS - Free Report) is America's largest pet pharmacy, delivering prescription and non-prescription pet medications and health and nutritional supplements for pets. PetMed Express has an average four-quarter positive earnings surprise of 7.3%.

Outerwall Inc. offers automated retail solutions. Its offerings consist of Redbox (R) entertainment, Coinstar(R) money services and ecoATM (R) electronics. Outerwall has an average four-quarter positive earnings surprise of 75.5%.

Tennant Company (TNC Quick QuoteTNC - Free Report) specializes in the design, manufacture, and sale of non-residential floor maintenance equipment and related products. The company has an average four-quarter positive earnings surprise of 11.5%.

Entegris, Inc. (ENTG Quick QuoteENTG - Free Report) is a leading provider of materials management solutions to the microelectronics industry including, in particular, the semiconductor manufacturing and disk manufacturing markets. Entegris has an average four-quarter positive earnings surprise of 20.7%.

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.

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