Welcome to the first day of my ugly Christmas tropical shirt parade that will go on for the next few days as we get closer to the holidays. This is one of my favorite times of the year, and I’m really starting to get excited for the Christmas and New Year’s celebration.
But today, I want to talk again about our momentum strategy. I know a lot of you are fairly new readers, so I’ll provide a quick overview.
Most of our strategy is based on buying companies at low multiples of earnings and assets values as well as special situations that have non-market-dependent payouts. We also love momentum stocks. Momentum is the idea that a trend in motion tends to stay in motion, and it’s pretty much the opposite of valuation-oriented investing.
But it still works really well. In fact, buying companies at low multiples of assets and earnings and companies with strong price momentum are the two proven ways to beat the market long-term. These have worked forever, and for a lot of psychological and economic reasons they’re probably going to continue to work to provide market-beating returns.
Normally, if you are a valuation-sensitive and special situation investor, you think momentum is just ridiculous… The idea of buying stocks regardless of valuations. And if you’re a momentum investor, you can own better known, popular stocks that are attracting a lot of institutional buying pressure, so you typically think buying on valuation and special situations is just ridiculous.
But they both work extremely well. And if you take your portfolio and make it 50% valuation and special situations and 50% momentum stocks, studies show that both will get to their ultimate destination and provide higher long-term returns. But they’re going to take different paths to get there.
When one zigs, the other zags. When valuation is working well, momentum may not do quite as well. And when momentum is red hot, valuation investing may have a hard time keeping up. They both get you to higher returns, but their price movements are going to run counter to each other in the short term.
Both are going to get to higher returns, but history tells us a 50/50 portfolio is going to do so with less volatility than a pure valuation or pure momentum strategy. So, I’m not going to pick one. I’d rather do both, as they both work and can make us a lot of money and reduce volatility.
Now, there is “herky-jerky” momentum, which can have a lot of ups and downs along the way. Those types of stocks are typically going to lose you money. It’s really tough to stay in them with all of the price movement. You’re probably going to time it wrong.
The other type of momentum is smooth, up-and-to-the-right momentum, where the stock moves 1% a day… Nice and smooth momentum that’s driven by powerful improvements in the fundamentals. We want to see sales and earnings growth, margin expansion and positive earnings surprises attract institutional buying pressure and bringing in the big money on a steady basis.
A perfect example of that is NVIDIA Corporation (NVDA), which is on the top of just about everyone’s list. The company is growing like crazy, with over 40% earnings growth per year over the last five years, and sustained growth is anticipated.
NVDA is the future. They’re a high-end semiconductor company that makes chips for use in gaming primarily. But down the road, it’s going to be about data centers, artificial intelligence and connected, driverless cars… Their chips play a major role in all of these advanced technologies.
To get to where we want to be with artificial intelligence and data centers, NVDA is going to play a huge role that’s going to drive earnings and sales growth higher, which is going to continue to attract institutional capital and drive the stock price higher a little bit each and every day.
Now, the company has had 27% sales growth leading to 40% earnings growth, which means that margins have been continually expanding over the last five years. As it moves from gaming to artificial intelligence, connected cars and data centers, I think the margins will continue to improve.
NVDA is going to get a 50% jump in profits this year alone as money continues to flow into the company’s coffers both from gaming and the new and advanced uses for its chips. We’re not going to get to the future of technology without NVDA making a lot of money. And that’s going to keep institutions piling into the stock, giving us that smooth, up-and-to-the-right momentum.
All of the analysts love this stock, and they’re always too low on their earnings estimates. The company is continually beating earnings estimates, which means Wall Street is constantly scrambling to raise their estimates, which raises their valuations of the company, which continues to bring in the institutional cash, giving us the kind of momentum we want to see.
The price-earnings multiple is higher than I’d like to see, but it’s being driven by strong sales and earnings growth. It’s not a story stock. It’s a real business with outstanding fundamentals that’s going to keep growing for an extended period of time. So, we can use this fundamental momentum and price momentum to ride this stock a lot higher over time.
It’s looks like this is going to be one of the ultimate artificial intelligence plays. Artificial intelligence is the wave of the future, and it’s going to touch everything, including your car, your job and even your health. It’s going to play a major role, and NVDA is going to be a huge part of that journey.
So remember… Momentum, combined with value, can make you a lot more money than you ever thought possible, and it can provide a much smoother journey by cutting down the volatility. When one strategy is zigging, the other is very profitably zagging.
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