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Value investing and momentum


ValueSlant
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I have been thinking about how momentum might be incorporated into a value investing framework. Here is one thought on it in light of the crazy action in JVA in the past few months:

 

http://valueslant.com/2011/07/22/value-momentumthe-case-of-coffee-holding-co-jva/

 

Basic idea would be to look for stocks that are in hot sectors but are still undervalued from fundamental perspective and could use momentum as a value unlocking catalyst when the momentum investors "find" the stock. Would be interested in hearing about if anyone has tried this as a defined strategy or if you have any current stock ideas along these lines.

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you might want to visit the 'mechanical investing' board at motley fool. mostly they are a bunch of statistically-inclined geeks, but there's a handful of bi-polar value guys there too who have a quant bent. especially look for posts by mugofitch. he's one of the most prolific posters there as well at the fool berkshire board.

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Guest Hester

It would be a nearly impossible strategy to carry out in my opinion. Value and momentum are often the opposite. Occasionally one can find a stock with price momentum that is also undervalued or is selling at low multiples, but very rarely. I've owned one for the last year, SPA, but it would be nearly impossible to fill a portfolio with these names. It's hard enough finding 10 or 20 undervalued stocks, much less 10 or 20 undervalued stocks with momentum.

 

By the very definition, a "hot" stock or a stock in a hot sector has a lot of buying and is popular among investors. A stock with those characteristics, for it to be undervalued would be an extremely rare event. Value investors need to look for uneconomical or forced or a copious amount of sellers, not buyers.

 

I think one would be forced, whether conciously or sub-conciously, to buy less and less inexpensive stocks in the pursuit of momentum, and that would have disastrous effects.

 

The problem with combining strategies, even global macro and TA with value investing, is that each strategy is so hard to implement on it's own,combining them would be very difficult.

 

My $.02

 

 

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Hester- I think I am proposing something different than trying to buy stocks with price momentum that are still cheap by value standards. I agree that would seem hard to implement, although I have seen some investors who try to do something along those lines.

 

I was proposing buying stocks that have not exhibited price momentum and are cheap and safe from a value perspective but are in a sector where a lot of the other names do have price momentum (and are probably richly valued). Theory being that you basically have a free option that momentum investors grab a hold of it as the next "hot thing", and if not you are just left with a good value investment.

 

This probably wouldn't be a stand alone strategy but just a point to consider in the course of research if you are of the value investing persuasion that likes to look for catalysts. I also don't know how common opportunities like these are as I have not consciously looked for them in the past.

 

Thanks for the perspective on combining strategies, I know many feel that way.

 

 

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Guest Hester

Oh Ok, yeah I miss understood you and should of read your blog post more carefully.

 

I think that's a better strategy, although the only problem is at any given time there is only a few hot sectors, and therefore the investor would be concentrated in those industries. But as you said if it's just a side part of an overall strategy it should be fine. It will still be very tough to find cheap stocks in hot sectors though.

 

Does anyone know of an example of a cheap stock in a hot sector currently? Cloud computing is hot but the economics are worse than people think, and I don't know of any cheap stocks. Coffee is hot but no more cheap ones that I can find. Social networking too but nothing selling below a gazillion times revenue.

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When buying a cheap stock that has go down, I try to use technical analysis to find a good entry point.

 

A rare good argument I have heard from technical analysts is that even if you are a fundamental guy, before buying a fallen knife, wait for a graphic that is showing some king of bottoming.

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When buying a cheap stock that has go down, I try to use technical analysis to find a good entry point.

 

A rare good argument I have heard from technical analysts is that even if you are a fundamental guy, before buying a fallen knife, wait for a graphic that is showing some king of bottoming.

 

Out of curiosity, how can you predict that it is the bottom or near it just by looking at a graph of past trades? If that actually worked, wouldn't technical analysts be the best-performing investors?

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I was proposing buying stocks that have not exhibited price momentum and are cheap and safe from a value perspective but are in a sector where a lot of the other names do have price momentum (and are probably richly valued). Theory being that you basically have a free option that momentum investors grab a hold of it as the next "hot thing", and if not you are just left with a good value investment.

 

This probably wouldn't be a stand alone strategy but just a point to consider in the course of research if you are of the value investing persuasion that likes to look for catalysts. I also don't know how common opportunities like these are as I have not consciously looked for them in the past.

 

 

 

That method still faces the problem of all technical analysis, which is that there are multiple pathways to every price action and no method to determine the relevant pathway. The price action is an indicator of a catalyst(s) but is not in itself a catalyst.

 

In this age of Carson Blocks and Whitney Tilsons (referring to their promotion, not integrity or quality of research), wouldn't it be better to simply purchase the cheapest stock and then broadcast your thesis?

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Slant - I've been following a blogger that uses a couple of interesting momentum strategies. One is style timing of major asset classes. It's similar to the "ivy Portfolio". Another combines the portfolios of about a dozen value investors (public co/funds and hedge funds). Then lists the holdings by a momentum ranking which includes addl info like number of portfolios holding the stock. The premise of the strategy is to invest in the higher momentum positions.

 

I've invested in a couple of the better performers with mixed results, but no losers! These aren't small/micro caps, more large/mid caps.

 

I was doing well with CapitalSource (CSE), but it has slipped back a little. Valeant Pharma (VRX) has been very good. I'm going to continue using the strategy for idea generation  

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  • 2 weeks later...

http://www.psyfitec.com/2011/07/perpetual-novelty-santa-fe-style.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+ThePsy-fiBlog+%28The+Psy-Fi+Blog%29

 

 

When Arthur and colleagues modelled a simple stock market by allowing investors to modify their expectations in response to market changes - which were themselves formed by expectations in an endless recursive fashion - they found that if people didn’t change their future expectations very often the simulation once again settled down to an equilibrium in line with the classical models, under the rational expectations approach. However, if their expectations changed more frequently the market never reached equilibrium and weaved about randomly, oscillating between periods of stability and periods of great volatility.

 

As the researchers state, this helps to explain:

 

    "One of the more striking puzzles in finance: that market traders often believe in such concepts as technical trading, "market psychology", and bandwagon effects, while academic theorists believe in market efficiency and a lack of speculative opportunities. Both views, we show, are correct, but within different regimes."

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Really interesting topic. It seems that from the world of quant investing and a whole pile of dough is invested by the quants ,Relative strength, which is one measure of momentum, has a pretty prominent weighting in most models. It would seem that cheap by most definitions would preclude it from any highly ranked momentum measure. However it would seem pretty easy to buy the most reasonably valued companies with a high momentum ranking would be a pretty easy policy to implement. Whether it ads Alpha is questionable. What you are proposing is done a lot already I think.

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