The stock of Zoom Video rises from $70 in early 2020, to above $500 by October, drops to $350 in January of 2021, drops again to $150 a year later, only to fall to $70 by the time this article was conceived. Teledoc, the remote medical appointment company, runs up from $80 to $200, then spikes up to $290, only to fall back to $25-30 in 2023. Tesla shares go from $50 to nearly $400, but you needed to buy early…the stock then declined 75% back to about $100 in the final months of 2022. Is this wisdom, or madness on display? I believe that a highly volatile style of investing called “momentum investing” is being used, in one form or another, by many investors to exaggerate the price moves of stocks with exciting stories.
What Is Momentum Investing?
The principles of momentum investing are basically to buy only stocks with the fastest current earnings per share growth, ideally where that growth rate is accelerating, exceeding the expectations of Wall Street, and where the stock price, like its earnings, will accelerate higher. Momentum investors may place little importance on stock valuation, perhaps with the idea that they will sell those stocks before growth slows and the stock’s extremely high valuation becomes an important issue.
Momentum investing these days can be accomplished either by people sitting at computer screens hitting “buy” or “sell” buttons, or it can be coded into software, to follow a rules-based exercise, often referred to as an algorithm. Algorithmic management (trading) in the last decade or two has become a dominant force in our markets, and software does not hesitate to sell stocks that are already falling or buy stocks that are already soaring. Thus, transactions that took days to execute decades ago now occur rapidly, in seconds or minutes, sometimes creating overwhelming price moves.
The Evolution of Momentum Investing
The momentum investment style evolved over time with many contributing to its development. One early systemized approach is thought to have been invented by Arnold Bernhard, who studied the Crash of 1929 and determined that owning only the stocks of the fastest-growing companies would be the most effective way of investing soundly. He founded a research company called Value Line Investment Survey in 1936 to implement his theories on momentum, and during the postwar bull market of 1948-1965, this method worked, and Value Line became a global investment resource. At Bernhard’s death in 1987, Value Line had 134,000 subscriptions worldwide.
Value Line’s formula for determining the attractiveness of a stock includes valuation, but only with a small weight. The big weights are given to price strength, the rate of earnings growth, “earnings surprise” and earnings revisions. Value Line wants to see Wall Street constantly raise earnings targets, likely to stimulate more buying.
A handful of other investors made fortunes in similar fashion. In the 1960s, this included fund managers Jack Dreyfus and William O’Neil. In the 1980s and 1990s, they included Richard Driehaus and Louis Navellier. The momentum style is tricky. Many more practitioners, including many hedge funds, have failed in their efforts. Stocks owned by momentum managers can turn on a dime, and the style is very high risk, requiring constant attention and a willingness, bordering on ruthlessness, to sell very quickly if these stocks begin to decline. This makes for very emotional experiences, sometimes hard to endure and repeat for the fund investors and fund staff.
For many lay investors, taking losses is likewise wrenching. As a fan of Warren Buffett, I appreciate his more ”valuation-based” approach. He seeks to avoid overpaying due to the excitement of a business enjoying a great, but temporary, prosperity that can fade with the business cycle. Thus, if his stocks are not overpriced when purchased, they are less likely to suffer serious declines during his ownership. As gravity is to life on Earth, valuation is to the stock market. It will tend to hold stock prices in a valuation range regardless of recent news, thereby making long-term ownership more palatable and a less stressful position.
MONTAG Wealth’s Investment Styles
At MONTAG Wealth, we have the tools to practice a variety of investment styles, including value, growth, GARP (“growth at a reasonable price”) and even momentum. Adapting to what the market is rewarding is a must and we evolve with time. But we also believe that focusing on stocks with strong valuation-based premises for their current price is usually the best way to strive for reliable, long-term returns. This is our dominant method year-in and year-out, and is one more reason our motto: Investing for Generations remains such a fine fit.
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed.
Any securities identified were selected for illustrative purposes only. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.