Value Or Momentum? Try Both.

Let's go back in time 30 years. Remember those “Taste great / less filling” Miller Lite beer commercials from the mid-1980s? You could roughly divide the world's beer-drinking population into two rival factions: Those that insisted that Miller Lite tasted great…and those that insisted it was less filling. I believe many men lost their lives fighting over this in bars. And I suppose as far as causes go, it's as good of a cause as any to die for.

I consider Miller Lite to neither taste particularly great nor be particularly easy on my stomach. As a native Texan, my heart will always belong to Shiner Bock.

But I digress. We're not here today to discuss beer dogmatism but the far more practical world of . As with Miller Lite fans, you can roughly divide the investing world into two camps: Those who favor value strategies and those that favor momentum strategies.

Both camps will insists that the academic research – and real world experience – prove that “their way” beats the market over time. And both camps are absolutely right. Simple value screens like Joel Greenblatt's “Magic Formula” have beaten the market by a wide margin, and research has shown that a strategy of screening stocks based on simple momentum criteria also beats the market over time.

So if value works…and momentum works…what would it look like if we combined the two?

Pretty good, actually. Quant guru Patrick O'Shaughnessy wrote an excellent piece last year in which he parses the universe of stocks into value and momentum buckets. Take a look at the following table, taken from O'Shaughnessy's article.

 

The bottom row of the table represents the top 20% of all stocks by momentum. The returns get gradually better as you move down the value scale. In other words, momentum stocks that are cheap outperform momentum stocks that are expensive. And it's not by a small margin. The cheapest high-momentum stocks returned 18.5% per year, whereas the most expensive high-momentum stocks returns 11.6%.

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