3 New York Stock Exchange Homebuilders: When Value and Momentum Converge


I am a value investor that believes in the long-term ownership of good businesses purchased at attractive valuations. In my humble opinion and experience, this is the surest and perhaps most prudent way to build wealth through investing in the stock market. However, value investing does not always provide instant gratification. In fact, the exact opposite is likely to be true more often than not. The reason is plain and simple. Value often comes when good companies go out of favor, this is especially true in bull markets like we have been in the last several years. Almost by definition, when stocks are out of favor it further implies that their near-term performance may not be all that attractive.

Recent studies have validated those assertions by pointing out that in the short run sentiment rules stock price action. Of course, the primary sentiments are fear and greed. I have always stated that fear is the most powerful and therefore most dangerous. However, at the same time, do not underestimate how dangerous greed can be. Nevertheless, stocks that have short-term momentum because of positive investor sentiment can and often do defy logic in the short run. Simply stated, in the short run, highly popular stocks can become significantly, and I might add, dangerously overvalued. However, this can continue for months or even years. As I often say, they do not ring a bell at the top or bottom of the stock market.

On the other hand, the same studies have pointed out that over the longer run (which the studies defined as 7 years or more) fundamentals rule. In other words, the company’s intrinsic value based on fundamentals will eventually and inevitably manifest. This is often referred to as reversion to the mean from a statistical perspective. However, I simply see it as the market continuously seeking efficiency or value. This contrasts with the notion of an always efficient market. Rather than being always efficient, I see the market as always seeking efficiency. Therefore, an efficiently-valued market is eventually what the investor will get. But at any point in time the market may not be efficiently valuing stocks.

Nevertheless, and with all that said, momentum investing can be very profitable over short to intermediate periods of time. For example, we are currently seeing a lot of extremely, and I would add, dangerously overvalued stocks in the tech sector. Moreover, these high valuations have gone on for quite some time. Years in many cases. Still, since fundamentals do not support these nosebleed valuations, investors purchasing them are simply acting as proverbial “greater fools.” The greater fool theory simply suggests that you foolishly pay more for a stock than it’s truly worth solely on the basis that a fool greater than you will come along and pay you more. This sometimes works for a while, but eventually bites you where it hurts.