Picking up the momentum

Some months ago, I wrote that "there's momentum, and then there's momentum". I caught flak from readers, many of whom thought it was a joke. However, the statement was serious. Few terms in investing have such a dual personality as momentum. There really are two kinds of momentum in stock prices.

As I'd pointed out, following prices is the most basic trading method, and it works. When a stock price rises, there's always an underlying reason. It could be good: investors have discovered why the price should legitimately be higher. Or bad: prices are rising because somehow they've started rising, and people are buying hoping prices will keep rising. Effectively, these are the two different types of momentum I mentioned. A rise in stock price is a signal - it could be meaningless, misleading, or useful.

In the world of stock movements, not all signals are created equal. Sometimes, prices dance to their own tune, rising or falling for no fundamental reason whatsoever. This is the meaningless signal, a common occurrence in markets where a critical mass of traders jump on board simply because others are doing so. Then there's the misleading signal, which is more of a problem. Here, prices might initially move for seemingly valid reasons, but then they take on a life of their own, detaching from those initial catalysts. But it's the useful signal that we're really after. This is when price momentum aligns with improving fundamentals. Valuations rise, but they're underpinned by tangible growth in earnings, sales, or market share. Its momentum is built on a bedrock of business performance, not just market hysteria.

Following that concept, we have recently made an evolutionary change to our stock-rating system. For years, we've prided ourselves on delivering insightful, fundamentally driven equity research, which we have described and discussed in detail in this issue's cover story. The addition of momentum as a factor to our stock prices represents more than just a new metric-it's a broadening of our perspective on what drives stock performance. While our foundation remains rooted in fundamental analysis, it can hardly be ignored that market sentiment and investor behaviour play crucial roles in a stock's journey.

Why this change? In our years of studying markets, we've observed instances where fundamentally strong companies failed to deliver the expected returns. Conversely, we've seen stocks defy traditional valuation metrics, driven by factors beyond balance sheets and income statements. This occasional disconnect between theory and practice prompted us to revisit our methodology.

By incorporating momentum into our framework, we aim to bridge this gap. We're not abandoning our belief in solid fundamentals. Rather, we're complementing it with insights into how the market perceives and values companies. This evolution didn't happen overnight. Our research team has spent months rigorously testing and validating this new framework. We've applied it to historical data, analysed its performance across market conditions, and fine-tuned it to ensure it adds genuine value to our analysis and ratings.

It goes without saying that our core philosophy stays unchanged. Our focus on quality, growth, and valuation remains as strong as ever. The addition of momentum doesn't replace these fundamental pillars-it enhances them. The financial markets will continue to evolve, and so will we. Our vision is to stay at the forefront of stock analysis, continuously refining our methods to provide you with the most relevant and actionable insights.

In this issue's cover story package, you'll find an exploration of our updated framework, including case studies demonstrating its application. We encourage you to dive in, explore the new stock screens on Value Research Online, and see firsthand how this evolved approach can benefit your investments.

Also read: The momentum formula