Like many investors, I’ve long been fascinated by the concept of momentum stocks—shares in companies that keep growing and growing. The growth in revenues drives profits and, theoretically, the stock’s value.
Many of today’s market rock stars, including Google (NASDAQ: GOOGLE), Amazon (NYSE: AMZN), (Netflix: NASDAQ: NFLX), Apple Inc. (NASDAQ: AAPL) and Costco Wholesale (NASDAQ: COST), are momentum stocks. The theory driving these stocks is that the new markets these companies create are capable of generating unlimited growth.
This is the case with Google, which has seen its TTM revenue grow from $42.76 billion in September 2012 to $54.23 billion in September 2013 and $67.91 billion in September 2014. That is an increase in revenues of $25.15 billion in around three years. Google also reported a year to year TTM revenue growth rate of 20.13% on Sept. 30, 2014.
Amazon.com’s growth is even more astounding; the online retailer reported a TTM revenue of $57.26 billion in September 2012 that grew to $70.13 billion in September 2013 and $85.25 billion in September 2014. Amazon’s revenues have grown by $27.94 billion in just three years. It also reported a year to year TTM revenue growth rate of 20.40% on Sept. 30, 2014.
Costco reported a TTM revenue of $101.22 billion in November 2012; that figure grew to $106.46 billion in November 2013 and $114.49 billion in November 2014. Costco’s revenues grew by $13.27 billion in three years. It was growing at a rate of 7.39% on Nov. 30, 2014.
At each of these companies, revenue growth driven by momentum has led to high stock values. Costco was trading at $143.42 a share on Jan. 9, 2014, Amazon was trading at $296.93 a share on Jan. 9, 2014, and Google was trading at $500.72 a share on Jan. 9, 2014, which was its lowest price of the year.
Does Momentum Equal Share Value?
When you look at these three stocks in different sectors—retail, online retail and search/software—the momentum sector theory seems to pan out. Yet there’s an interesting problem here: a company can have a lot of momentum and see little or no effect on its share price.
A perfect example of this was Kroger (NYSE: KR), which was trading at $65.85 a share on Jan. 9, 2014. Kroger reported a TTM revenue of $94 billion in October 2012 that grew to $99.17 billion in October 2013 and $106.48 billion in October 2014. That makes for an increase in revenues of $12.48 billion in three years; not bad for a grocery store. What’s truly interesting is that Kroger’s rate of quarterly year to year TTM revenue growth on Oct. 31, 2014, was 11.20%, which was higher than Costco’s.
The lesson we can draw from this is obvious: momentum does not equal stock value. Part of the reason for this is the way Mr. Market values stocks. Currently Costco, Netflix and Amazon are fashionable, while Kroger and Google are not. Another is that some times of momentum are easier to notice than others.
Another might be the kind of momentum; much of Google and Kroger’s growth seems to be driven by acquisitions. Kroger’s growth over the past year was driven by its acquisition of the Harris Teeter grocery stores on the East Coast in January 2014. Kroger is also boosted by problems at competitors such as Safeway (NYSE: SFWY), Albertsons and Wal-Mart.
Costco’s growth seems to be more organic; it has boosted its sales largely through its stores and is doing a good job of competing with longtime rivals Wal-Mart Stores (NYSE: WMT) and Target (NYSE: TGT). Costco also benefits from a lack of competition in its sector: club stores; its only rival that operates nationwide is Wal-Mart subsidiary Sam’s Club. Costco has no real competition in Canada, where Sam’s Club pulled out in 2009.
Like Costco, Amazon.com is growing organically, but it is also boosted by being at the forefront of a growing business: online retail. Online retail sales are booming these days; Amazon being the industry leader and best known brand grows by, well, default. The real problem is that the momentum is not of its own making; it is simply riding a wave. Costco and Kroger are generating the wave while taking advantage of a growing economy and changing shopping habits.
Retail also provides some cautionary tales for momentum fans. Wal-Mart can be seen as the ultimate momentum stock; over the past 40 years it has grown into the largest retailer on Earth with revenues of $483.79 billion. The interesting thing is that Wal-Mart appears to have lost its momentum even though it is still registering impressive growth.
Wal-Mart reported a year to year TTM revenue growth rate of 2.86% on Oct. 31, 2014. That does not sound very impressive until you look at Wal-Mart’s TTM revenue figures. Wal-Mart reported a TTM revenue of $464.26 billion in October 2012; that grew to $474.36 billion in October 2013 and to $483.79 billion in October 2014. That means Wal-Mart’s revenue increased by $19.53 billion in three years.
The implication of this is obvious. Wal-Mart has not lost its momentum; it has just grown so large that it needs to grow at a very high rate to attract attention. The lesson here for investors is that growth rates can be deceptive. A high rate of growth does not mean a company is making a lot more money. A low rate of growth doesn’t mean a company is not doing well.
What Happens When Momentum Dies
A more ominous sign is when a company’s revenue suddenly freezes at a specific rate. That might mean a company has reached the limits of its growth or its business model. An example of this seems to be going on at Target, which reported a TTM revenue of $71.86 billion in October 2012; that grew to $73.81 billion in October 2013 and fell to $73.7 billion in October 2014. Target’s revenue only increased by $1.84 billion during a period heralded as a “retail recovery.” Yet Target had a quarterly TTM revenue year to year growth rate of 2.75% on Oct. 31, 2014.
It appears that Target has lost its momentum; it is no longer capable of growth. That does not mean Target is starting to die like Sears Holdings (NYSE: SHLD); instead, it has reached the limits of its business model. When a company reaches that stage, it must enter new markets to grow. That’s why Target, which has never operated out of the U.S. before, suddenly moved into Canada a couple of years back.
It is also why Wal-Mart is expanding online and experimenting with convenience stores, neighborhood markets, and other kinds of stores. Such growth can lead to momentum, as Kroger’s success in the gas station business shows.
The lesson for investors to take away here is that momentum is a tricky business. Simply having it does not equal profit, and determining how much momentum a company has can be difficult. Only several years of revenue figures can show you how much momentum a company actually has.
Nor is momentum investing for the faint of heart. If you like steady profits, dividends might be a better gauge of a stock. On the other hand, if you want to see your money grow, momentum cannot be beat.