Financial pundits, news commentators, and various bloggers describe momentum investing as buying the best stocks of last 3, 6 or 12 months and holding them in hope the price advance will continue in the future. They view it as a blind strategy, where hordes of people buy a stock simply because it went up in previous period. In their words, momentum stocks are very volatile and risky with high P/E ratios, and market participants involved in them are fools. This is a completely wrong perception. Anybody who thinks they can just buy last year's winners without any analysis and make money should visit a doctor.
Momentum effect has been well documented by the academic community as well as fund management companies. Father of momentum investing, Richard Driehaus has long advocated this approach, along with Gerry Tsai (man who made Fidelity into a powerhouse), Martin Zweig, Philip Fisher, William O'Neil and many others. These fund managers have become legends by buying fast growing stocks in up trends for cheap prices. Do you think they just look at past year's winners and buy them every year? Probably not, nobody is that stupid.
My strategy is to use price momentum as a primary stock screener. In other words, I look at stocks making new highs for longs, and stocks going down for shorts. After that I apply various growth and value criteria (min. 10% sales growth, low debt to equity, high ROE, low P/S ratio) to narrow it down to a few stocks. These I check more thoroughly, and determine whether they have potential and are selling for a fair price.
When a price moves up or down, there is usually a reason for it, somebody is buying or selling the stock and I have to know why.
Wall Street and Financial Media divide stocks into various categories like growth, value, momentum, dividend and so on. They fail to see, that there is no need for division because it's all connected. As Warren Buffet said: "Growth is merely a part of value equation". When I am buying a stock, I want it to have a competitive advantage, high growth rates, be reasonably valued, and already in uptrend, if it pays a dividend that's a bonus. If it doesn't grow fast, is overvalued or in a downtrend I simply won't buy it.
So what am I? A "value momentum growth dividend investor"! Sounds retarded, doesn't it? In fact I am just doing what every successful and intelligent investor advocates: Buy a great company for a good price and hold it as long it's making money. Price momentum is just a part (an important one in my strategy) of the whole process, and is a valuable addition to growth and value criteria in my opinion.
I don't look at how much a stock made in the past 6 months or year. It doesn't matter at all. If you look at the winning stocks of past 100 years, they have one thing in common: all went up in price significantly and made hundreds of new highs year by year. When I look at stocks making 52-week highs today, I know there are many tomorrow's big winners there, and you just need to do the homework to identify them. Momentum definitely works as a great indicator, and does not deserve the "overvalued hype stocks" tag on it.
Do you have questions or comments about momentum investing? Post a comment below!