Finding Value Using Momentum

Abstract

Value investing has been one of the cornerstones of equity investment strategies. This article provides a new methodology to select value stocks using the concept of <i>relative value</i> across firms. Results show that using multiple value ratios as foundation blocks provides better risk-adjusted returns than using a single ratio, as used by the Fama–French HML factor. The use of trends in fundamental ratios helps capture value in a stock portfolio in a new way. The trend in value metrics ranks firms that are not just cheap compared to the cross-section but also those that have become cheaper over time. The results show that this relative value method proves effective for individual value parameters and when combined to create a composite value model. Trends carry incremental information not captured by common factor models and control variables. The authors construct a composite value model that uses trends in six value ratios. Momentum when combined with value generates enhanced return performance, as documented in various academic literatures. The authors extend the discussion on the combination of momentum with value using three different methods.