Momentum Investing vs. Value Investing: Investing Types Explained

Not sure what the differences between momentum investing vs. value investing are? They are two different styles of investing that look to achieve different investing goals based on looking at different metrics. 

Warren Buffet, for example, is a value investor. He adheres to the Benjamin Graham school of value investing. Value investors like Buffet look for securities with prices that are unjustifiably low based on their intrinsic worth. 

The lesser-known investing legend Richard Driehaus is credited as the father of momentum investing, which wasn’t made popular until the 1980s. Momentum investors like Driehaus select stocks with the greatest earnings growth potential. The idea is that short-term, high-growth performance often indicates the potential to continue growing exponentially.

Learn about which investing style is right for you and how to invest like a pro using one, both, or even other styles.

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Momentum Investing vs. Value Investing: The Definitions

Let’s start with a basic clarification for the beginner investors (hi and welcome!) Momentum investing and value investing are two different styles of investment strategies.

Momentum investors seek to buy assets that have recently risen in price, while value investors seek to buy undervalued assets with the goal of selling at a higher price later on. 

Value investors are interested in buying shares from companies that they believe offer potential for future growth, regardless of whether or not that company has recently been performing well. 

Now, let’s break down each style of investing a bit more in-depth.

What is Momentum Investing?

Momentum investors have faith that the future will be much like the past and that assets that have performed well in recent months or years will likely continue to perform well into the future. 

Momentum investing is an active form of investment strategy where traders monitor stock market or crypto exchange rankings and other indices for information on which investments are currently doing well. Based on that information, traders will buy shares of the companies that are increasing in size or value, while simultaneously selling off (or "shorting") stocks that have been decreasing in price. 

Overall, momentum investing is not about looking at the intrinsic value of a stock or company, but rather the investor's own psychology and the general market trend. Momentum investing is a short-term strategy that can yield profits over the long-term through holding periods varying from several days to several months. 

At the end of the day, momentum investors are looking for businesses that have already proven their worth by demonstrating increasing stock prices and higher earnings.

What is Value Investing?

Value investing is a more passive form of investment strategy where investors look at the intrinsic value of an asset. The goal is to find assets that they believe hold long-term value and will be purchased by other investors at a higher price in the future (a.k.a., they’re looking for an undervalued investment). 

If you try to invest using a value investing mindset, you will be looking for stocks that are valuable, whether now or, according to your analysis, in the future. However, more than that, you only want to pick companies that are trading below their value.

A stock offers a great value if its share price is lower than the hypothetical sum of its parts. 

Imagine you have two stocks, A and B, which are similar in nature but one has been priced well below the other for no apparent reason. The undervalued stock would be the one you would want to analyze further. Why is it undervalued?

Momentum Investment Strategy Example

Okay, so if you think that momentum investing is the right investing style for you, it's time to form an investment strategy. Momentum investors will often look at factors such as market cap, annual sales, sales growth rates, profit margin, etc. 

While you might think that momentum investors would be interested in the price-to-earnings ratio (P/E ratio), they actually don’t tend to analyze it until after the stock has started to improve. Once it has, you can use this metric as an indicator of how high the stock has the potential to rise in price.

This means that when forming your investment strategy, you should place more value in these factors (relative to other investing styles). We also suggest looking at the head and shoulders pattern or the death cross chart pattern. Going back to our example above, you could choose to invest in stocks that have a:

  • P/E ratio of 1.5x below the industry average of 3.0
  • Likewise, as a momentum investor, you’ll do well looking at liquidity

Some top momentum stocks that were slated to perform well this year were mostly green energy stocks. Just take a look at Tesla, which saw a 700% growth last year.

Value Investment Strategy Example

How do you invest as a value investor? Value investors usually look at the current assets minus the total liabilities of a company. This is referred to as price-to-book ratio (this is best used when analyzing banks, for example). They also look at price to free cash flow, price-to-earnings ratio, and the enterprise value/EBITDA ratio.

They also look at income statement ratios like return on equity and profit margin when deciding what to invest in. Momentum investors, on the other hand, are not concerned with valuations. Rather, they focus their attention on technical factors. Hopefully, by now, this distinction is becoming clearer!

If you want to create an investment strategy using value investing, you'll want to look at stocks that:

  • Have a low price to earnings ratio
  • Trades for a price-to-book ratio of less than 1 (even better if it’s 0.5)
  • Feature consistently high profit margins

Some top value stocks that are popular at the moment include stocks such as Kroger, Merck, and Verizon. Verizon’s dividend yield is currently hovering at around 4.4% and the market cap is about $233.75 billion. Note: Even Buffett’s buying Verizon.

Momentum Investing vs. Value Investing: Which is Better?

So, which investing style is better, momentum investing or value investing? 

It’s hard to say. Momentum investing is an investment strategy that relies on short-term price trends. This means that it doesn't look at the status of underlying fundamentals and metrics, to pick stock investments. Momentum investors are looking for stocks that have recently made strong gains in order to make even stronger gains. 

Overall, value investing offers lower fluctuations in your account balance and significant tax advantages. It does, however, require a bit of patience. Willing to play the long game? Think you can choose stocks wisely (we can help with that)? If so, value investing offers just as much return as momentum does but with less risk.

At the core, one of the biggest differences here is long-term vs. short-term investments. Value investors understand that investing is a long-term game that must be played patiently. If this is something you think you’d do well with, then value investing is a great option for you.

Regardless of the investing style you choose to follow, it’s definitely best to start with the basics of learning how to invest first. Familiarizing yourself with the right terminology, investing styles, and what even makes a good investment in the first place can help you understand which styles and strategies suit you best.

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