Value and momentum investing are two of the most popular and well researched approaches that allow investors to target equities with specific characteristics. It’s easy to understand why. After all, investors tend to like a good bargain (i.e., value), and they certainly like it when stocks are rallying strongly (i.e., momentum).

Both value and momentum stocks offer intriguing potential, and there should be room for both in a diversified investment portfolio. However, we believe that combining these two factors into a single solution is far better than allocating to them in separate silos. Screening for both value and momentum characteristics can, in our opinion, help manage risk and build a durable portfolio with excellent long-term potential.

The Base Case

Value investing is based on a simple idea: find stocks that are undervalued by most investors and hold them until the market acknowledges their fair value. These are stocks trading for less than their intrinsic worth, often measured by metrics like price-to-earnings (P/E) ratios or price-to-book (P/B) ratios. Momentum investing takes a different tactic, though the idea is also straightforward: buy stocks that have been trending upwards with the expectation that their strong performance will continue. These are often companies enjoying rapid growth or gaining attention due to positive news and improving market sentiment. It's easy to see why investors might want to isolate these two “style” factors and build portfolios of stocks either trading below intrinsic value or enjoying fast growth. As always, however, the details on how one allocates matter.    

Value and Momentum—A Potent Combination

Both value and momentum investing have their unique advantages, but they also come with challenges when used separately. For instance, value stocks can sometimes remain underpriced for long periods of time. Other times, these stocks may be go “on sale” due to rapidly deteriorating fundamentals. Nobody wants to invest in what is often referred to as a “value trap.” On the other hand, momentum stocks sometimes become overpriced due to excessive investor optimism. So, how do you manage the risks while maximizing the potential of both value and momentum?

By combining value and momentum factors in one strategy, investors should be able to identify stocks that are not only attractively priced but also showing signs of strong near-term performance. Value investing provides the foundation for finding solid, long-term opportunities at a reasonable price. Momentum helps capture short-term market trends and avoid stocks that may have fallen precipitously due to deteriorating fundamentals.

Value and momentum are both attractive style characteristics that appeal to investors and can work at different points of the economic cycle. But we think the real power is in their combination. Screening for both momentum and value characteristics in a single solution seems like a smart way to build a portfolio.