Momentum vs Value Investing: Can You Use Both Together?
At first glance, momentum investing and value investing appear to be philosophical opposites. The value investor seeks stocks trading below intrinsic worth — yesterday's losers that the market has overlooked or overpenalized. The momentum investor buys stocks that have been rising and avoids (or shorts) those that have been falling — yesterday's winners continuing their run.
Yet both approaches are grounded in rigorous academic evidence and have delivered persistent excess returns over long periods. More surprisingly, combining them into a single composite strategy has historically produced better risk-adjusted returns than either factor alone. Understanding why — and how to do it practically — is the focus of this guide.
This article is for educational purposes only and does not constitute financial advice.
What Is Momentum Investing?
Momentum investing is the strategy of buying stocks that have outperformed over recent historical periods and either avoiding or selling short stocks that have underperformed.
The most commonly studied version is 12-1 momentum: measure each stock's return over the past 12 months, skipping the most recent month (to avoid short-term reversal effects), then buy the top performers and short the bottom performers. This specific formulation was rigorously documented by Narasimhan Jegadeesh and Sheridan Titman in their landmark 1993 paper published in the Journal of Finance, which showed that U.S. stocks exhibiting strong price momentum over 3–12 month horizons continued to outperform over the subsequent 3–12 months.
The finding was robust across multiple time periods and later replicated in virtually every major equity market globally. Kenneth French and Eugene Fama, who had built the foundational three-factor model of market/size/value factors, eventually added momentum as a fourth factor — acknowledging it as a persistent, real phenomenon that their original model could not explain.
What practitioners mean by "momentum" can vary:
- Price momentum: Pure price return over a historical window
- Earnings momentum: Stocks with upward earnings estimate revisions
- Fundamental momentum: Improving operating metrics (revenue acceleration, margin expansion)
Most factor studies focus on price momentum, but earnings and fundamental momentum have similar empirical properties and are arguably more intuitive for fundamental investors.
Why Does Momentum Work?
The behavioral finance explanation for momentum centers on market under-reaction to news.
When a company reports genuinely positive news — an earnings beat, a contract win, a margin improvement — the stock typically rises. But academic evidence suggests investors initially under-react: they anchor too strongly to prior expectations and do not fully reprice the stock to reflect the new information immediately. Instead, the repricing occurs gradually over subsequent months as the information diffuses through the market and more investors update their views.
This gradual diffusion creates the momentum effect: the stock that beat earnings in Q1 tends to continue outperforming over Q2 and Q3 as the full market catches up to the new information.
A second behavioral mechanism is herding and trend-following: many participants extrapolate recent trends, creating self-reinforcing price moves. Trend-followers, technical analysts, and systematic funds all buy rising stocks and sell falling ones, which amplifies momentum effects in the short run.
Momentum's known risks:
- Crashes: Momentum strategies experience severe drawdowns during sudden market reversals. Stocks that have risen for extended periods can fall very rapidly when sentiment shifts.
- Crowding: In popular momentum names, many investors hold the same positions. When they all try to exit simultaneously, the exit can be chaotic.
- Transaction costs: Momentum portfolios require frequent rebalancing. High turnover erodes returns, especially in less liquid markets.
What Is Value Investing?
Value investing is the practice of identifying stocks trading below their intrinsic value — the present value of their future cash flows or asset base — and buying them with a margin of safety.
The intellectual foundations come from Benjamin Graham, who articulated the concept of intrinsic value and the margin of safety in Security Analysis (1934) and The Intelligent Investor (1949). Graham's core insight was that the stock market oscillates between over-optimism and over-pessimism, and disciplined investors can exploit the pessimistic episodes by buying fundamentally sound businesses at temporarily depressed prices.
The Fama-French three-factor model (1992) provided academic validation: stocks with low price-to-book ratios (the canonical "value" screen) systematically outperformed high price-to-book stocks over long periods. The value premium was attributed to either compensation for genuine economic risk (distressed companies are riskier) or persistent behavioral mispricing (investors over-extrapolate poor recent results).
Common value metrics used in factor research:
- Price-to-Book (P/B): The original Fama-French value factor
- Price-to-Earnings (P/E): Cheap on current earnings
- Price-to-Free Cash Flow (P/FCF): Cheap on cash generation
- EV/EBITDA: Enterprise value relative to operating earnings
- Price-to-Sales (P/S): Useful for unprofitable growth companies
Why value works: The behavioral explanation is over-reaction to bad news. When a company goes through a difficult period — earnings decline, competitive pressure, management turnover — investors tend to overshoot in their pessimism and price the stock below its true worth. Mean reversion in fundamentals (things rarely stay as bad as the worst fears) and in sentiment (the stock re-rates as fears prove overdone) produces the subsequent outperformance.
The Problem: Factor Cycles and Underperformance Periods
Both momentum and value are real, documented factors — but neither works all the time.
Value's worst decade: The 2010s were historically bad for traditional value metrics in U.S. equities. Low-P/B stocks massively underperformed high-P/B stocks for almost a decade. The explanation likely involves structural changes (intangible assets like software and brands are poorly captured by book value), very low interest rates (which favor long-duration growth assets), and the concentration of economic value creation in capital-light technology businesses.
Momentum's worst moments: Momentum strategies experience periodic "crashes" during rapid market reversals. The most famous was in the 2008 financial crisis, when momentum portfolios — which had shorted beaten-down financial stocks — suffered devastating losses when those stocks rebounded sharply in a brief window.
Value and momentum tend to be negatively correlated. When value is underperforming (growth stocks rising), momentum often captures those rising growth stocks. When momentum crashes (rapid market reversal), value often performs well (beaten-down stocks bounce hardest). This negative correlation is precisely why combining them is so powerful.
The Value-Momentum Composite: Better Together
Asset management firm AQR Capital Management has produced some of the most influential research on combining value and momentum. Their work, summarized in papers including "Value and Momentum Everywhere" (Asness, Moskowitz, Pedersen, 2013), demonstrated that a composite portfolio combining both factors achieved higher Sharpe ratios (return per unit of risk) than either factor in isolation — across multiple asset classes and geographies.
The intuition is straightforward: you are diversifying across two factors that are negatively correlated with each other. When value is in a drought, momentum often picks up the slack. When momentum crashes, value cushions the blow. The combination smooths the return profile considerably.
Practical composite construction approaches:
The simplest method is to rank stocks independently on both value and momentum, then combine the rankings. A stock ranking in the top quartile on value and top quartile on momentum is a strong composite candidate. A stock ranking poorly on both is a strong candidate to avoid.
More sophisticated approaches use weighted scoring that incorporates additional quality metrics (profitability, balance sheet strength) as a third factor — since high quality tends to amplify value and dampen momentum crashes.
The ValueMarkers VMCI Approach
The ValueMarkers Composite Indicator (VMCI) already reflects this multi-factor philosophy. The scoring system blends:
- Valuation (35%): How cheap the stock is relative to earnings, cash flows, and assets
- Quality (30%): Balance sheet strength, profitability consistency, return on capital
- Growth (20%): Revenue and earnings growth trajectory
- Momentum (15%): Recent price performance relative to the broader market
The 15% weight on momentum is intentionally modest — enough to tilt the portfolio toward stocks with improving market recognition while keeping the strategy anchored in fundamentals. A high-scoring stock on VMCI is typically one that is undervalued on fundamentals and beginning to show improving price action — the combination that historically marks the early stages of a value recovery trade.
A Practical Composite Screen
For investors who want to build a systematic value-momentum screen from standard metrics, consider this framework:
Step 1 — Value filter:
- P/E below 15
- Price-to-Free Cash Flow below 15
- EV/EBITDA below 10
Step 2 — Quality filter:
- Piotroski F-Score of 7 or above (screens for improving financial condition across nine criteria)
- Debt/Equity below 0.5
Step 3 — Momentum filter:
- 6-month price return positive
- 6-month price return in the top 40% of the sector (not just flat — relative strength matters)
Step 4 — Sanity check:
- Remove micro-caps below $500M market cap (liquidity and data quality issues)
- Remove companies with recent accounting flags or restatements
Stocks passing all four filters combine cheap valuation, financial quality, and improving price momentum — the composite sweet spot. This screen typically captures 15–30 stocks in a normal market environment.
When Each Factor Is Most Likely to Work
Value tends to outperform:
- In early economic recovery (beaten-down cyclicals rebound)
- When interest rates are rising from low levels (growth multiples compress, value multiples stable)
- After prolonged growth stock outperformance (mean reversion opportunity)
- In sectors with stable, predictable cash flows
Momentum tends to outperform:
- In extended bull markets with clear trend persistence
- During periods of accelerating earnings growth
- When macroeconomic regime changes are underway and the market is recognizing new leaders
The composite tends to outperform:
- In most market conditions — the diversification effect is consistent
- Particularly in environments with neither strong bull nor strong bear trends, where individual factors are more prone to underperform
The Behavioral Edge of Combining Both
There is a human dimension to the value-momentum combination that is often underappreciated. Pure value investing is psychologically brutal: you are regularly buying stocks that feel terrible to own — declining businesses, negative headlines, falling prices. The willingness to hold through continued underperformance before the eventual recovery is enormously difficult for most investors.
Pure momentum investing has the opposite emotional profile: it feels great while it works (you own winners) but the crashes are sudden and severe. Cutting losses quickly requires a discipline that many investors claim to have but few actually maintain.
The composite approach creates a more balanced emotional experience. The momentum component means you are not always swimming against the current — some of your holdings have recent price support. The value component means you have a fundamental anchor that helps you hold through volatility rather than panic-selling at the worst moments.
Understanding the "why" behind each factor — under-reaction for momentum, over-reaction for value — also helps investors maintain conviction during periods when a factor is temporarily underperforming. Every factor goes through multi-year droughts. The investors who capture the long-run premium are those who understand and believe in the underlying mechanism deeply enough to stay disciplined during those difficult windows.