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Monday, March 26, 2012

Value Or Growth?


Recent Real Money Columns on the Subject:

That age old argument raised its head around Chez Melvin yesterday. Do I buy the best or the worst stocks? Do I want the high PE stocks that everyone talks about or the low PE stocks? Do I want to own the most exciting companies with sext new products or stocks of which none of us have ever heard? Which works better, value or momentum. I have addressed in this past and better minds than mine have also tackled the subject. The research section at LSV  Asset Management’s website (  is full of scholarly articles on the  subject. Well known super quant invest Cliff Asness has done some spectacular work on the value versus momentum conundrum available on his website at

Both of these approaches work and have worked over long periods of time. I am of the optinion that if you tell me about your personality, goals and the time frame in which you chose to operate I can probably tell you which school of though you should favor. If I know you and your approach to life I can probably tell you which type of stocks on which to focus on your trading and research effort. The argument comes up so often and value and momentum types tend to argue about the topic like Red Sox and Yankees in a tight pennant race I thought I would share my definitive thoughts on the subject.

If your time frame is one month or less you really are not an investor, you are a trader. Fundamentals like earnings, sales and profit margins do not matter so much for you. You need to be aware that in this time frame market direction is a huge factor in the stock selection process. Trading individual stocks in this time frame is simply trying to gain some excess return above and beyond the stock market. If you are bullish of the market in general you want stocks that will rise a little farther than the indexes. If you are bearish you want stocks that will fall a little farther than the market. If I were trading this time frame right now and was bullish my trading universe would contain names like Apple (AAPL), Google (GOOG) and Cisco (CSCO) that were near or at new highs and had strong momentum. If I was bearish I would be looking to short stocks like Alliant Techsystems (ATK), Baker Hughes (BHI), or Ancestry.Com (ACOM) that are flirting with new lows and lagging the market in general.

If I am trading from the long side in the 1 to six month time frame I am a pure momentum guy.  I want stocks that have strong price momentum, earnings momentum, improving margins, exciting new products and a sexy story. I am looking for stocks that have super strong fundamentals and I do not care what price I pay for these gems. They need to be growing and growing fast. I want institutions to be net buyers of the shares as I need their buying pressure to push my stocks higher over my time frame. I am looking for stocks that are at or near short term highs in price as well. My trading universe contains names like LuluLemon (LULU), Coinstar (CSTR), Under Armor (UA) and Chipotle.  I want great companies with strong price momentum. If the fundamentals start to slip or the price rolls over, I am out of the stock. In this time frame I am just surfing the sweet spot.

If I am bearish I look for the opposite.  I want to short stocks with horrid fundamentals and a lagging stock price. My universe would probably include stocks like Lexmark (LXK), Sony (SNE) or even Skechers (SKX). I want to find stocks with poor fundamental and prices that are weakening. When trading in this time frame you want to keep in mind that predicting the direction of the stock market is still very much part of your decision. Determining market direction correctly will be a large component of overall return.

Successful practitioners of this approach tell that occasionally they get a stock in their portfolio that stay in buy mode for an extended period of time. Fundamentals keep improving and the stock keeps showing positive price momentum. Stocks like Apple and Priceline (PCLN) might be an example of one of these stocks. They can be tremendous wealth builders but my friends tell me that they are always long (or short) all of their stocks, including the big winners, from last night. The fundamentals need to keep improving (deteriorating) each quarter and the price needs to continue showing strength (weakness) measured against the broader market.

As we move out in our time frame into the 6 to 12 months segment of the markets I think we need to change our approach somewhat. In this time frame momentum is still very important but valuation starts to become more of a factor. The problem with super high momentum stocks is that when the mo-mo stops it gets ugly quick for those stocks with high valuation multiples. If I am looking at a longer holding period I want to consider adding value to my momentum approach. I am still surfing but I am surfing using stocks with solid fundamentals and lower valuations that are less likely to collapse if the market stumbles along my journey. I want to look for value stocks that have started to improve and the market is noticing or growth stocks with lower PEG ratios that have not risen to unstable heights.

When I started in this business in the age of Quotrons , ticker tapes and paper stock guides the one to two year neighborhood was just about everyone lived. Investors bought stocks and started thinking about selling after the one year capital gains period was reached. For right or wrong this was the most common holding period for the investors I met and worked with in the good old days. Even mutual funds were sensitive about turnover and taxes back in the olden days. Very few people live in this area anymore as most of the focus has become short term in nature.

The absence of heavy competition makes this a pretty fertile area in my opinion. If this was primary time frame I would be looking for fallen angels, turnarounds and undiscovered growth stocks exclusively. The approach of buying Value Line Stocks ranked 1 or 2 priced under $10 works very well. These are stocks that have fallen out of favor with Wall Street and the rankings are indicating some signs of a turnaround. Right now stocks like JetBlue (JBLU), Micron Technology (MU) make the list as turnaround stories that could easily rise by 50% or more over a 12 to 24 month time frame in my opinion. I also think undiscovered growth stocks with low institutional ownership like Eastern (EML) and Orchard Tissue (TIS) work very well in this time frame.

Crash buying of blue chips is in this time frame as well. When everything goes to hell and no one is buying stocks the one to two year investor should be buying with both hands. Wall Street is the only place where the 100 year statistical storm hits every three or four years. When it looks as though the world is going to end and the commentators on the financial networks look hung-over in the morning, buy the big names like Disney (DIS), Johnson and Johnson (JNJ) and Microsoft (MSFT) with the idea of selling them when the sun comes out on Wall Street once again.

When you move out over two years you are now in my neighborhood. This is the neighborhood of owners. It does matter if we own 100 shares or a million we think or ourselves as owners of the underlying business. I look to buy attractive assets at fire sale prices and own them until the full value is realized. I kick over rocks looking to buy companies in a good business at desperate prices. I am also looking to be the buyer of last resort in distressed situations where panic and fear is in the air. I have no stop loss or exit strategy when I buy a stock. In most cases I will own it until something changes for the worst and I think that any hope of the comonay being fixed is gone, the company fails, the company is taken over or is discovered by Wall Street and valuations soar to what I consider to be overvalued prices. I focus on safe and cheap and with an occasional venture into longshots with a risks and rewards highly skewed in my favor. I do not care how long I own a stock. I am very comfortable owning a company for five years but I am not upset when one gets taken over at a premium a year or two in either. I want to buy extremely cheap and sell extremely dear and time is not that much of a factor.

There is no sense to arguing value versus momentum. They both work. The discussion needs to be about time frame, desired outcomes and personality.

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