Four Ways Value Investors Can Use Momentum

Episode Summary

Executive Summary: The episode argues that momentum is one of the strongest complements to value investing, despite many value investors’ discomfort with buying stocks that have already risen. The hosts outline four practical ways to use momentum: blending it directly with value, improving entry points into value names, filtering out value traps, and using trend/factor momentum to time exposure to value.

Main Topics: Why momentum pairs well with value (Priority: 5/5): Jack argues momentum is likely the best factor to combine with value, even though it feels counterintuitive because value investors prefer cheap stocks rather than stocks with rising prices. Sleeve method for combining factors (Priority: 5/5): The hosts describe a portfolio construction approach where one sleeve holds top value stocks and another sleeve holds top momentum stocks, creating equal exposure to both factors. Consensus method for blending factors (Priority: 4/5): Instead of separating sleeves, investors can rank stocks on both value and momentum together and select names with exposure to both, reducing pure factor extremes. Using momentum to improve value entries (Priority: 5/5): Momentum can be used as a secondary screen to choose among similarly attractive value stocks, or to set a minimum momentum threshold before buying. Avoiding value traps (Priority: 5/5): The discussion emphasizes that value traps cannot be eliminated entirely, but very weak momentum can serve as a strong warning signal and help filter out the worst candidates. Trend following and factor timing (Priority: 4/5): The hosts discuss using factor-level trend or momentum to reduce exposure to value when value is in a downtrend, noting that this is the least supported but still plausible use case. Market-cycle behavior of value and momentum (Priority: 4/5): They note that value and momentum can align or diverge depending on the market cycle, affecting both correlation benefits and return potential.

Key Arguments: Momentum is probably the best factor to pair with value, even though value investors are often least comfortable using it. Combining value and momentum can improve portfolios because the factors tend to work at different times in the market cycle. A sleeve approach preserves strong exposure to both pure value and pure momentum, while a consensus approach blends them into names with both traits. Momentum can be used tactically to choose better-timed entries into value stocks without abandoning value as the primary strategy. Setting a minimum momentum filter or choosing stronger relative strength among similar value names can reduce weak entries. Extremely weak momentum in a value stock often signals that something has gone wrong fundamentally, making it useful for identifying value traps. The lowest 5% of momentum names can be excluded from value portfolios as a practical anti-trap screen. Trend/factor timing may help reduce exposure during prolonged value underperformance, though evidence is mixed and less robust than for stock-level momentum. Momentum-based timing may be especially useful when value stocks are broadly weak and the market is signaling disagreement with the value case. Momentum and value can sometimes become aligned, and when they do, returns can be especially strong rather than merely diversified.

Data Points: Momentum exclusion threshold: Lowest 5% of database - Jack says their value strategies filter out the absolute worst momentum stocks, specifically the lowest 5%. Relative strength scale: 1 to 99 or 1 to 100 - Justin explains that relative strength is typically reported on a scale used to assess stock momentum. Example relative strength cutoff: Above 20 - Jack gives an example minimum momentum threshold for value stocks. Portfolio example size: 20 stocks - Used to illustrate the sleeve method: 10 top value stocks plus 10 top momentum stocks. Value sleeve size example: 10 stocks - Half of the example 20-stock portfolio is allocated to top value names. Momentum sleeve size example: 10 stocks - Half of the example 20-stock portfolio is allocated to top momentum names.

Pivotal Quotes: "momentum is probably the best factor to couple with value, but it's probably the one that value investors are the least comfortable with" — Jack: Introduces the central thesis that momentum is a strong complement to value despite investor bias against it. "we'll take the absolute worst momentum stocks, you know, in our case, the lowest 5% of our database, and we'll filter them out of our value strategies" — Jack: Explains how they use momentum as a negative screen to reduce value traps. "momentum, whether you use it a little bit or you use it a lot, momentum. Is the evidence is very strong that momentum can be used to enhance a value strategy" — Jack: Summarizes the episode’s main takeaway on integrating momentum into value investing.

Implications: Listeners should think beyond pure value orthodoxy: momentum can improve selection, timing, and risk control in value portfolios. For practitioners, the most practical uses are factor blending and trap avoidance, not full-on market timing.