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Hello, Reader.
Tom Yeung here with today’s Smart Money.
In early 2005, Staples launched a new ad campaign that introduced the world to the “easy” button.
Customers soon began asking where to buy this button. And by the fall, the office supply store chain had turned the advertising prop into a money-making product. Staples would sell almost a million units within the first several months, and many more over the coming years.
Now, wouldn’t it be great if investors also had a similar button to press?
Well, they might.
Momentum investing has become one of the easiest ways to get ahead. The strategy is a simple one: Buy stocks that have been going up, and sell stocks that have been falling.
While momentum can deliver quick gains, patience has historically delivered bigger ones.
So, in today’s Smart Money, I’ll share why the best long-term returns often come from a mix of turnaround stocks and fast-growing companies trading at fair prices.
Then, I’ll show you where to find them.
The Momentum Trap
There is a case to be made for chasing the market’s hottest stocks. Since 2014, investors could have used a surprisingly simple strategy:
- Start with the Russell 3000 Index.
- Buy the top 10% of stocks based on their performance over the past six months.
- Sell the bottom 10%.
This strategy worked well: The winning stocks gained 12.3% over the next year, while the losing stocks returned 7.5%.
For years, it seemed like you didn’t need deep research or complicated financial analysis. Simply buying stocks that were already rising often worked. That’s been the story for much of the market for the past decade-plus.
But over longer periods, the results flip.
After removing penny stocks, financially weak companies, and businesses with falling sales or earnings, yesterday’s losers become the better investment. Over the next 24 months, the former winners returned 8.2%, but carefully selected former losers returned 13.5%.
In other words, it’s possible to cruise along with an “easy” strategy in the short run (i.e., chasing momentum). But chasing winners also comes with risks.
Investors who piled into hot stocks before the crashes in 2000 or 2008 suffered steep losses. (More recently, Micron Technology Inc.’s (MU) 25% drop showed how quickly high-flying stocks can fall.)
That’s why the best long-term returns come from a thoughtful selection of turnarounds paired with faster-growing names at reasonable prices.
Of course, buying well-priced companies for the long haul is challenging. Dips often happen in the first year of holding before a rebound in the second.
Consider Nvidia Corp. (NVDA), now the most valuable company on Earth. An investor who bought precisely when ChatGPT was launched in November 2022 would be sitting on roughly 1,100% gains.
Getting the timing right, however, was tough. An investor buying a year earlier would have been handed 50% losses. And anyone exiting at that point would have done so at the worst possible moment.
Why Bargains Win
At , our strategy is to look at “boring,” undervalued stocks, like copper miner Freeport-McMoRan Inc. (FCX). Freeport itself was purchased in 2020 after a roughly 35% decline a year earlier.
It is now up over 250%. And Eric has booked multiple triple-digit gains along the way.
In fact, many of our top performers have done so well precisely because they were bought during dips.
The key is to look at companies with fundamental stories backing them up. Like a great bottle of wine or a first-class airline ticket, the lower these prices go, the more attractive they become.
Even in the face of painful, short-term moves, we’re happy buying these solid companies, and then checking them in 24 months. It’s only a matter of time before their quality shines through in prices.
The bottom line: By buying turnarounds, investors are setting themselves up to potentially triple the returns offered by the “easy button” of momentum investing. It’s not an effortless way to invest, but it can be more rewarding in the end.
Until next time,
Thomas Yeung, CFA
Market Analyst, InvestorPlace
