A review of the combination of value and momentum as a strategy for stock investing.
This article reviews the combination of value and momentum as a strategy for stock investing. The purpose is to emphasize the superior qualities of the combination compared to pure value or momentum strategies – with a particular focus on the underlying explanations.
Value and momentum are independently efficient stock investment strategies. Value and momentum have, however, proven to work far better in combination. Investing in stocks which at the time of investment contain both value and momentum has historically outperformed each of the two individual strategies – even with a relatively low risk. In other words, investors have in the long term been rewarded for investing in undervalued stocks with positive momentum.
Eugene Fama’s well-known Efficient Market Theory2, first published in 1970, has been widely questioned. Numerous studies have rejected the theory that all accessible and relevant information will at any time be discounted in the stock price and that it hence will not be possible to generate a consistent risk-adjusted excess return. In reality a number of well-documented anomalies contradict the theory. Two of these are value and momentum. The value anomaly demonstrates that it has in historical terms been possible to generate a consistent risk-adjusted excess return by investing in stocks that are undervalued in terms of various key ratios.
Similarly, the momentum anomaly demonstrates that it has in historical terms been possible to generate a consistent risk-adjusted excess return by investing in stocks with positive price or earnings momentum.
The first two sections of this article survey the value and momentum strategies and discuss why they work. The following sections describe the combined strategy – including the reasons behind its success and a characterization of the qualifying stocks.