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Covid-19 has shaken world markets and a question on the minds of many investors right now is how economic uncertainty will continue to affect small-cap shares like Cerillion (LON:CER).
Shares in the company are currently trading at 795p. But to assess whether the price is likely to fall or rally over the next 12 months, we need an objective way of telling whether it's able to withstand economic shocks and ride out market volatility. To do that, it's worth looking at the profile of the stock to see where its strengths are.
Importantly, we're interested in finding impartial ways of looking at Cerillion – something that takes emotion out of the analysis...
The good news is that there's evidence of it scoring well against some important financial and technical measures of quality and momentum.
Research shows that high quality stocks tend to be resilient, cash-generating businesses that can compound investment returns over time. Likewise, strong momentum in price and earnings is a pointer to positive trends that have the potential to continue.
Here's why these factors matter:
Why quality stocks pay off
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 Cerillion is its 5-year Return on Capital Employed, which is 16.1%. Good, double-digit ROCEs are a pointer to companies that can grow very profitably.
Harnessing the power of momentum
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.
This appears to be the case at Cerillion, where the share price has seen a 24.1% 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 Cerillion that you can find out about here.