Discover the key traits of value investing vs. momentum investing to better select stocks that meet your goals and fit into your diversified portfolio

Are you interested in value investing vs. momentum investing? Momentum stocks may move higher as traders buy these widely followed stocks on the latest upswings. But many of these shares are overvalued compared to other stocks. When the booms fade for those stocks, they tend to drop to much lower levels—and often very quickly.

Value stocks are generally good bargains, but not all bargain stocks offer good value. The search for value stocks that will rise, and hold their value over time, begins with sound fundamental investing. You look for stocks that are trading at prices that seem cheap in relation to their sales, earnings and assets. As well, these stocks will have what it takes to be successful in the long term, even if most investors haven’t yet anticipated just how successful these companies can be.

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Know the characteristics of value investing vs. momentum investing to make smarter investment decisions

Momentum investing is a strategy that aims to capitalize on continually improving news on a stock—especially positive earnings surprises. This means that momentum investors hope that recent winners will remain winners.

There’s nothing wrong with taking a closer look at stocks with momentum. But before you buy, make sure that they also offer some value in terms of their sales, earnings, assets and so on.

In contrast, the core of the long-term value investing approach is identifying well-financed companies that are well established in their businesses and for the most part have a history of earnings and dividends. They are likely to survive any economic setback that comes along, and thrive anew when prosperity returns, as it inevitably does.

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of rising sales, if not earnings, as well as a strong hold on a growing clientele.

High-quality value stocks like these are difficult to find. But when you know what stocks to look for, you can discover them.

Focus on consistency with value investing vs. momentum investing for long-term gains

In our view, your goal as an investor, particularly if you follow a conservative investing strategy based on our philosophy, is to make an attractive return on your investments over a period of years or decades. That is with the least amount of risk.

At the core of the Successful Investor approach to strong value investing returns is identifying well-financed companies that are established in their businesses and have a history of earnings and dividends. They are likely to survive any economic setback that comes along, and thrive anew when prosperity returns, as it inevitably does.

Value investors also have long-term mindsets when it comes to investing. Long-term wealth building strategies aren’t built by aiming for outsized returns. They are built over time, and most importantly, by learning not to repeat the market mistakes of the past.

Momentum investing has been around for a long time. In the academic world, the pioneering research on momentum investing came in a 1993 study by Narasimhan Jegadeesh and Sheridan Titman published in the Journal of Finance; both researchers were then at UCLA Anderson. The pair documented how strategies based on buying recent stock winners and selling recent losers generated significantly higher near-term returns than the overall U.S. market from 1965 to 1989.

A 2017 study by two academics from The Wharton School at the University of Pennsylvania looked back over 215 years and confirmed that the ability to earn premiums from a momentum strategy exists not just in U.S. stocks but also foreign stocks, bonds, currencies and commodities.

A Morningstar study used the Russell 3000 and MSCI World ex USA indexes to examine a simple momentum strategy. Using back-testing, the study covered the period between December 1979 and February 2019 to compare each index’s beginning-month value with its average value over the previous 12 months. If the index’s beginning-month value was higher than the 12-month average, the study’s portfolio would continue to hold the index for the next month; otherwise, it would convert it to cash.

When researchers applied the momentum strategy to the Russell 3000 index, the return was slightly below that of a buy-and-hold strategy using the same index. Still, under the momentum strategy, volatility was considerably lower and the maximum loss was less than half of the buy-and-hold strategy. In comparing the returns for the World ex USA index— momentum versus buy-and-hold—momentum delivered a better return, less volatility and narrower losses.

Note, though, that it’s far from certain that past trends will continue in the future—especially with today’s uncertain markets.

Use our three-part Successful Investor approach to build your overall portfolio

1. Invest mainly in well-established, dividend-paying companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; and Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

How many of your value investing picks were really momentum buys?