value and opportunity

Momentum is one the concepts I really have some difficulties with. As a traditional value investor, one would basically ignore market movements and invest purely based on intrinsic value.

However if one looks at different reasearch papers, “momentum” seems to be an important indicator. For instance Tim du Toits latest research, momentum combined with value metrics created some astonishing results for the 1999-2011 period.

Also for example this article shows based on a back test that pure momentum trading strategies can produce theoretically 10 % p.a. outperformance.

Interestingly, the mentioned AQR US momentum fund isn’t really outperforming the indeces in real life. Bloomberg shows an underperformance of this momnetaum fund against all major US indices since inception in mid 2009.

Definition & application of momentum for grwoth stocks

I have been looking around a little bit, but there seem to be different definitions for “momentum”.

The more simple approaches seem to look at a trailing time period (1M, 6M, 1Y) and define momentum either as the best performance within a certain group of stocks (i.e. low P/B) or in general relative performance agains an index.

I have found this site where they give the following advice for “momentum growth stocks”:

One of the things to spot momentum stocks is the relative strength of the stock compared to the overall market over a specific timeframe. Most momentum investors seek at a stock which has outperformed at least 90% of all stocks over the past 12 months. When major indices declines, a great momentum stock exhibit strength by holding or even exceeding their highs. When the major indices rally, momentum stocks typically lead the rally and make new highs outpacing the market.

Potential momentum stocks should show in their balance sheet that they are growing at an accelerated rate.

Another factor is the Earnings per Share growth. At least a 15% year-over-year earnings per share growth is needed to qualify a momentum stock. Stocks with accelerating rates of EPS growth over previous quarters are also considered.

In addition, a positive forecast by at least some analysts regarding the Company’s earnings in necessary for identifying momentum stocks. Further, momentum investors also looks at whether the reported earnings exceeded the analysts forecasts compared to the last quarter.

A company can’t grow its earnings faster than its Return on Equity, which is the Company’s net income divided by the number of shares held by investors, without raising cash by borrowing or selling more shares. Many companies raise cash by issuing stock or borrowing, but both alternatives reduce earnings-per-share growth. For momentum investors, a potential stock should show an ROE of 17% or better.

This simple strategy at the moment is quite succesfull. If we look at two typical “MoMo” stocks Chipotle and LuluLemon we can see this in action. The “fundamental requirements” are clearly in place like this table shows:

	EPS Growth		ROE
	Chipotle	Lululemon	Chipotle	Lululemon
2007	67%	292%	14%	41%
2008	11%	30%	13%	29%
2009	61%	34%	19%	30%
2010	42%	109%	24%	39%
2011	19%	49%	23%	37%

As one could expect, analysts go wild for both stocks and as for any respectable US comapny, earnings are ALWAYS above (carefully guided) expectations and of copurse both shares are in the top 10% performers.

And both stocks are still in their “parabolic” phase:

However, as my two “MoMo” short positions, Netflix and Green Mountain showed, once “Momentum” dissapears, those stocks can loose 50-80% of their value in the matter of a few days or weeks:

“Fundamentally”, momentum is usually explained the following way:

The capital market is not really efficient, so positive and negative information does not transform directly into securitiy prices but this takes some time.

However, in my opnion, there is also a “psychological” component for momentum:

Many investors prefer to see an immeadiate positive feedback on an investment decision. Even for myself, I tend to look more closely to daily or even intraday price movements when I just have bought a stock. With a “positive” momentum stock, there is a very high probability that the stock continuos to climb and you see direct positive feedback (and feel like an investing genius),

With a declining stock, on a short time horizon it is very likely to see a loss directly after buying the stock (and feel like an idiot for not waiting longer).

As an “intrinsic value” investor one should not care about the short term direction of stock prices, but never the less it still takes a lot of conviction to buy into a falling or underperforming stock.

The big question for me would be: Can momentum add value to an investment process based on intrinsic value ?

Intuitively I would say that extremely negative momentum could be a warning sign for a “value trap”. On the other hand, I can also see the argument for stocks where after a long decline some fundamental changes are occuring.

One of the stocks I have been tracking for a long time is Sto AG. Sto in the 90ties was one of the typical construction related stocks. After the reunification, prices of construction and construction related stocks exploded. However in the mid 90ties the boom went bust and construction stocks suffered. In the 2000s, then Sto could participate in the boom for energy saving, multiplying its earnings sevral times.

I did a very crude check on Sto with regard to relative performance: I compared annual returns with the dax since 1992 ( I diddn’t get earlier numbers). The result is quite surprising:

	P/E	EPS	Last price	12m change	DAX 12m Change	Delta
1992	11.9	1.51	17.985
1993	20.7	1.47	30.523	69.7%	46.7%	23.0%
1994	13.2	2.58	33.901	11.1%	-7.1%	18.1%
1995	12.8	2.51	32.098	-5.3%	7.3%	-12.6%
1996	18.0	1.83	32.915	2.5%	27.8%	-25.2%
1997	14.1	2.12	29.927	-9.1%	47.1%	-56.2%
1998	16.8	1.11	18.618	-37.8%	17.7%	-55.5%
1999	12.0	1.69	20.32	9.1%	39.1%	-30.0%
2000	13.2	1.39	18.342	-9.7%	-7.5%	-2.2%
2001	13.1	1.17	15.285	-16.7%	-19.8%	3.1%
2002	7.6	1.27	9.71	-36.5%	-43.9%	7.5%
2003	15.0	0.96	14.386	48.2%	37.1%	11.1%
2004	10.3	1.46	14.97	4.1%	7.3%	-3.3%
2005	8.3	2.41	20.05	33.9%	27.1%	6.9%
2006	3.9	7.35	28.591	42.6%	22.0%	20.6%
2007	6.7	7.29	48.855	70.9%	22.3%	48.6%
2008	5.3	8.05	42.794	-12.4%	-40.4%	28.0%
2009	7.1	8.60	61.057	42.7%	23.8%	18.8%
2010	10.3	8.98	92.17	51.0%	16.1%	34.9%

One can clearly see that once “negative momentum” occured in 1995, four subsequent years with strong underperformance followed. Sto shareholders basically missed the whole 90ties boom.

Then again the same happened in 2006: Once Sto really started to outperform, 4 more years of outperformance followed.

Another example: KSB

When we look at the same type of crude analysis, we see a less clear picture at KSB:

	P/E	EPS	Last price	12m change	DAX 12m Change	Delta
1992	10.2	19.32	196.847
1993	40.1	5.74	230.081	16.9%	46.7%	-29.8%
1994	41.8	4.59	191.734	-16.7%	-7.1%	-9.6%
1995	#N/A N/A	-18.82	121.687	-36.5%	7.3%	-43.8%
1996	#N/A N/A	-5.71	123.733	1.7%	27.8%	-26.1%
1997	18.2	11.35	206.562	66.9%	47.1%	19.8%
1998	9.5	17.82	169.238	-18.1%	17.7%	-35.8%
1999	18.9	5.92	112	-33.8%	39.1%	-72.9%
2000	14.2	5.8354	82.98	-25.9%	-7.5%	-18.4%
2001	15.0	5.32	80	-3.6%	-19.8%	16.2%
2002	8.4	8.65	73.09	-8.6%	-43.9%	35.3%
2003	19.4	7	136	86.1%	37.1%	49.0%
2004	27.1	4.67	126.5	-7.0%	7.3%	-14.3%
2005	25.9	5.85	151.43	19.7%	27.1%	-7.4%
2006	13.4	27.99	375	147.6%	22.0%	125.7%
2007	10.3	43.86	450.06	20.0%	22.3%	-2.3%
2008	5.1	70.17	360	-20.0%	-40.4%	20.4%
2009	6.7	61.32	409	13.6%	23.8%	-10.2%
2010	14.0	44.09	618	51.1%	16.1%	35.0%
2011	11.0623	40.95	453	-26.7%	-14.7%	-12.0%

For the first 4 years, momentum would have worked but in 1997, momentum would have failed us. However in the subsequent years momentum might have worked OK, although one would have missed the big jump in 2006.

Let’s finally look at one of the “true hidden champions”, Fuchs Petrolub which I regret deeply not to have bought in the past:

	P/E	EPS	Last price	12m change	DAX 12m Change	Delta
1992	23.0	0.10	2.414
1993	27.3	0.13	3.46	43.3%	46.7%	-3.4%
1994	23.3	0.17	3.848	11.2%	-7.1%	18.3%
1995	34.2	0.08	2.869	-25.4%	7.3%	-32.8%
1996	21.6	0.14	3.123	8.9%	27.8%	-18.9%
1997	13.0	0.27	3.544	13.5%	47.1%	-33.6%
1998	44.6	0.07	2.92	-17.6%	17.7%	-35.3%
1999	9.2	0.22	2.03	-30.5%	39.1%	-69.6%
2000	8.4	0.234	1.964	-3.3%	-7.5%	4.3%
2001	19.9	0.1089	2.162	10.1%	-19.8%	29.9%
2002	7.3	0.3207	2.327	7.6%	-43.9%	51.6%
2003	11.6	0.4152	4.816	107.0%	37.1%	69.9%
2004	17.4	0.4919	8.564	77.8%	7.3%	70.5%
2005	11.3	0.9394	10.57	23.4%	27.1%	-3.6%
2006	13.8	1.2413	17.163	62.4%	22.0%	40.4%
2007	13.5	1.5517	20.983	22.3%	22.3%	0.0%
2008	8.7	1.4867	12.943	-38.3%	-40.4%	2.1%
2009	11.9	1.70	20.217	56.2%	23.8%	32.4%
2010	13.7	2.39	32.9	62.7%	16.1%	46.7%
2011	11.7637	2.56	30.115	-8.5%	-14.7%	6.2%

Again we can see here longer stretches of under- and outperformance which clearly seem to imply some kind of momentum, persisting at least for some 4-5 years in this example.

Summary: Momentum is something which is is usually not connected to intrinsic value investing but with growth investing. However, some recent studies show that momentum also seems to be a factor in “value” stocks. A crude test with three examples from my long term “circle of comeptence” shows some anecdotical evidence for momentum in stock prices of “normal” companies and even “value companies”.

So this is definitely something to include in the investment process as additional aspect.

Edit: There is acutally a new Dilbert out referring to “momentum”: