Why it pays to factor in momentum

What should you look for in a stock? Good quality firms and cheapness are important, but don't forget about momentum. Investec's Philip Rodrigs reveals six on-trend stocks from his portfolio.

What drives share prices? Good quality firms do well; cheapness is at the core of value investing; but momentum (earnings surprise as well as technical) is also important. Investec's 4Factor equities team buys stocks where all four factors show strongly at once. We pay close attention to new clusters of attractive stocks, which gives us an early warning of emerging trends in the market. This has allowed us to benefit from a switch by investors from a value-orientated approach in global companies, to quality, high-yielding, long-term growth plays, often with a domestic UK bias.

A case in point is Dignity Funeral Services (DTY, 540p). The firm is benefiting as the continental trend to pre-pay for your own funeral catches on in the UK. Through its national network, Dignity offers customers the chance to fix funeral prices, which should allow market-share gains in the long-term. Meanwhile, highly predictable cash flows make it deserving of a premium valuation.

At the very cheap end of the spectrum is Revenue Assurance Services (RAS, 123p formerly XKO). The premise is simple: the company offers utility firms £1 in cash and asks for 25p in return. How does this make sense? RAS has found that 2% of all non-residential gas customers have not received a bill. By comparing data from the utility and Transco (the gas-pipe firm), RAS spots the mistakes and collects the revenue due. This money for free' business model has already captured a 30% market-share. With no competitors, the scope for growth is considerable, even before taking into account the electricity market, which is three times as large again. All this for an exceptional

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ten times forward earnings.

Another rapidly growing service is Individual Voluntary Arrangements (IVAs), which offer over-indebted people an alternative to bankruptcy by cutting debts to affordable levels. Banks benefit too they are typically able to recover more than if they were to enforce bankruptcy. Sentiment in the sector has taken a hit lenders have been surprised by the scale of the debt problem and are trying to implement arbitrary measures to stem the tide. But sparkling figures from Debtmatters (DEBT, 304p) show meteoric growth continues, as some UK consumers struggle with heavy debt burdens. It's also a fair bet that recent interest-rate hikes could hit home after Christmas, generating demand early next year, benefiting advice provider Accuma (ACG, 223.5p) too.

Chemring (CHG, 1,601p) is a defence firm that hit our radar in mid-2005. Despite a three-fold gain since then, it remains attractive. It supplies countermeasures, flares and missile propulsion systems to the defence sector. Demand has boomed as governments seek to protect personnel and aircraft better to spend thousands than lose lives. The market is focusing on a potential scaling back of Iraqi operations, but investors are missing the sustainable demand from re-stocking, equipping new jets and the substantial leap in profitability. Chemring remains great value for a world leader.

Finally, a misunderstood stock has recently made it into my top ten. The Innovation Group (TIG, 31.8p) only survived the tech bubble fall-out through a rescue rights issue. The circumstances of this month's rights issue couldn't be more different. The firm continues to capitalise on the potential for improving administration at insurers who have been slow to adopt IT, thwarting its attempts to sell its world-leading software. Undaunted, it has instead provided outsourcing services using its own software, which is achieving organic growth of 25% per year. Just 6% of revenue now comes from the lumpy one-off licence wins that led to the profit warnings that marred the group's past. Rapid earnings growth has beaten forecasts in the last two sets of results, leaving this global number-one firm on an attractive valuation for a high-returning secular growth story: just what the market is currently looking for.

Philip Rodrigs is manager of the Investec UK Smaller Companies fund