Much like a shot of nutrient-rich wheatgrass can add a “power boost” to your morning smoothie, a shot of momentum can add a big boost to your value investing portfolio, Validea CEO John Reese says.
The idea of focusing on hot stocks may make value investors, who tend to find bargain-priced stocks amid the beaten-down members of the market, cringe, Reese writes in his latest for Canada’s Globe and Mail. “But value stocks aren’t always falling. Nor are red-hot stocks always expensive,” he says. “While they are often portrayed as polar opposites, value and momentum are really two separate concepts. Value metrics give you a snapshot of what a stock’s valuation is at a given time, regardless of whether the stock has been rising or falling. You’ll find plenty of cases in which a stock is so cheap that it can get quite hot for an extended period, and still be undervalued.”
Reese says those are the kinds of stocks you want to key on. He discusses the research of quantitative investing guru James O’Shaughnessy, noting that O’Shaughnessy’s rigorous testing of various strategies has shown that the best approaches historically have included both value and momentum variables. He also cites other studies showing that a combination of value and momentum strategies has been very effective not only in the US stock market, but also in global markets for a variety of assets.
“The idea of combining value and momentum in a single stock-picking strategy makes a lot of sense,” Reese writes. “Momentum is a powerful force in investing. We human beings have a tendency to follow the crowd, which means today’s winners tend to keep winning. The problem occurs when the crowd pushes the winners far past fair value – tech stocks of the early 2000s are probably the best example of that. At some point (and there’s no way of telling precisely when), momentum won’t be enough to keep a vastly overvalued stock rising; when that happens, it’s often as though investors realize that the emperor has no clothes – that the stock is worth nowhere near what people have been paying it – and the trend can reverse. Before you know it, all of your gains can be wiped out. When you combine momentum with value, however, you avoid the risk involved with those high-flying, overpriced stocks, while still getting the benefit of the market’s momentum.”
Reese looks at a trio of stocks that currently have both strong momentum and attractively priced shares, and which also get strong interest from his “Guru Strategies,” which are based on the investing approaches of Warren Buffett, O’Shaughnessy, and other highly successful investors. Among the stocks he highlights: JetBlue Airways, which passes his Peter Lynch-based model.