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Some stocks are better placed than others to withstand the economic turmoil - but is Capital (LON:CAPD) one of them?
To understand why different shares respond to uncertainty in different ways, it pays to look at their strengths...
In bull markets, investors gravitate to speculative, unproven growth stocks as a means of achieving the best returns. But these stocks can collapse first in a crisis.
By contrast, high quality shares often get overlooked in bull markets. But it's these stocks that are often better at keeping their momentum and recovering quickest from periods of volatility.
Shares in Capital are currently trading at 91.0p but a question in the minds of many investors is how the price will respond to the Covid-19 uncertainty.
The answer is that there are some positive signs. Capital scores well against some important financial and technical measures, which suggests that it might have some exposure to two influential drivers of investment returns: high quality and strong momentum.
So why are these two factors important and where are the clues hidden?
When it comes to stock analysis, company quality tends to show up in high profitability and strong industry-leading margins. These kinds of firms are stable, growing and often have accelerating sales and earnings. They also have strong and improving financial histories with no signs of accountancy or bankruptcy risk.
One of the quality metrics for Capital is its 5-year Return on Capital Employed, which is 16.2%. Good, double-digit ROCEs can be a pointer to companies that can grow very profitably.
Positive momentum trends show up in share prices and earnings growth. You can find the clues in stocks that are trading close to their 52 week high prices and outperforming the market. They’ll often be beating broker estimates and getting forecast upgrades and recommendation changes.
There are signs of this at Capital, where the share price has seen a 11.7% return relative to the market over the past 12 months. Market volatility and economic uncertainty can be a major drag on momentum, but previously strong stocks can be quick to recover when confidence returns.
In summary, good quality and momentum are pointers to some of the best stocks on the strongest uptrends. This combination of factors can be a clue to finding shares that can deliver solid investment profits over many years.
In good times, these shares can become expensive to buy. But in volatile markets, there may be chances to buy them at cheaper prices.
What does this mean for potential investors?
Finding good quality stocks with strong momentum behind them is a strategy used by some of the world's most successful investors. But be warned: these factors don't guarantee future returns and we've identified some areas of concern with Capital that you can find out about here.