It’s hard for me to find true friends among my investment buddies…
You see, I believe that both “value” and “momentum” work in investing – and you’re not allowed to do that. You have to pick teams…
In the investing world, saying you believe in value AND the trend is like saying you are part of more than one political party… You simply can’t do that![ad#Google Adsense 336×280-IA]For example, I have friends who are diehard “value” investors.
These guys bow at the altar of Ben Graham and turn their noses up at any mention of “momentum” as if it’s beneath them.
They look at me like I’m foolish for thinking that any degree of “trend following” could possibly be useful.
Then I have friends who are “trend” guys, who quietly think the value guys are complete fools – totally barking up the wrong tree.
They wonder how I could possibly waste my time concerning myself with value.
I believe in both, though…
As regular DailyWealth readers know, my ideal investment has three characteristics…
1. It’s cheap (value)
2. It’s hated
3. And it’s in an uptrend (momentum)
So, which works better, value or momentum?
Portfolio manager Patrick O’Shaughnessy recently crunched the numbers on individual stocks, going back 50 years.
His simple study showed that both value AND momentum strategies beat traditional buy and hold.
But that wasn’t the most interesting result of his study…
You see, even though strategies built on value and momentum both beat the market over the long run, it turned out that both value and momentum had huge periods of underperformance.
So now, which is better? Which one is right?
It turns out, combining the two strategies together is best. O’Shaughnessy says…
The most powerful combination is a strategy that measures both value and momentum at the stock level. Both value and momentum have had three-year periods where they underperformed the market by more than 10% annualized. But the worst case for a 50/50 combination of value and momentum? Just 5.5% annualized underperformance over three years.
By combining the two strategies – in a 50/50 mix of value and momentum – you dramatically improve the periods of underperformance, as O’Shaughnessy explained. And by combining the two strategies, you improve the risk-versus-reward ratio versus either strategy by itself – which is the ideal result.
Why does combining the two work so well? It turns out that value and momentum strategies are not especially correlated. In short, one often zigs while the other zags.
O’Shaughnessy summed up his results…
Bottom line, the tortoise and the hare both have their merits: cheap valuations rule AND the trend is your friend. Look for stocks that have both.
In short, the best strategy over the last 50 years has been to own cheap stocks that are in an uptrend…
Source: Daily Wealth