Editor's note: You can't predict the stock market, but you can come close... Folks have long tried to understand what makes the market "tick" to determine the best stocks to invest in. And while many theories and factors have been presented by economists, one time-tested metric has been overlooked. Today's Masters Series was recently shared in the August 21 issue of the free DailyWealth e-letter. In it, Joel Litman – chief investment officer at our corporate affiliate Altimetry – explains "factor analysis" and shares the key metric that identifies stocks that could continue to soar...
The Overlooked Market Factor That Drives GainsBy Joel Litman, chief investment officer, Altimetry For more than 100 years, economists have been telling us that the market is efficient... It just makes sense. Of course the market reflects all the information available at any moment. And with millions of investors constantly staring at all that data, the market immediately reprices whenever new information comes out. That's what University of Chicago professors Eugene Fama and Kenneth French believed in the early 1990s... when they set out to explain why stocks move the way they do. Fama and French started by identifying metrics that could explain a stock's moves. They referred to these metrics as "factors." And when they introduced the idea of "factor analysis" in 1992, they believed three specific factors could explain 90% of variation in returns. Today, I'll examine those three factors. Then, I'll show you another crucial factor – one that Fama and French overlooked – that has proved its staying power time and again...
According to Fama and French, the three key factors in stock analysis were:
- How much the market as a whole moved
- The size of the stock relative to the rest of the market
- The stock's price relative to its book value
Starting with the first factor, it shouldn't come as a surprise that individual stocks are influenced by broader market trends. That said, as the second factor suggests, smaller stocks tend to rise more than the overall market does. Because of their size, fast growth is often easier for them to achieve than it is for larger stocks. And the third factor tells us that companies with higher valuations at the start of a period tend to underperform those with lower valuations. That might be a result of expectations. When a company is doing well, investors want to see more where that came from. And on the flip side, when a company is struggling, even slightly beating expectations can be enough to impress. Those three factors cover a lot of scenarios... So it made sense for Fama and French to focus on them. But they overlooked one critical factor... I'm talking about momentum. The idea behind momentum is simple: Stocks that have already risen are more likely to continue rising going forward. It seems straightforward enough. But to Fama and French, it was absurd. Past performance couldn't possibly explain future performance. That would imply that the market wasn't efficient. It would have meant that investors were ignoring obvious, easy-to-access data. Fama flat-out refused to acknowledge momentum at all... That is, until Cliff Asness – one of his doctoral students and teaching assistants – made him wade through the data. Asness' 1994 doctoral dissertation was all about momentum. He found that tracking an asset's past performance could explain a lot about where it would go in the future. As Asness likes to say, Fama was supportive of the research. But he didn't like the result. Asness went on to combine his momentum research with Fama and French's factors. He built an entire business around them called AQR Capital Management. And he's one of the most respected voices on factor investing in the market today. Unfortunately for Fama, momentum's influence has only gotten stronger over time. Meanwhile, many of the simplest factors Fama and French identified, like size and valuation, have proved to be unreliable at various times. Two factors are still consistently useful predictive tools, though... The first is quality, or how profitable a company is. There's simply no denying the power of strong, growing profits. The second – you guessed it – is momentum. It remains one of the absolute best ways to determine where a stock could go next. Combine these two factors, and you have a recipe for success. Regards, Joel Litman
Editor's note: Momentum dictates that AI will continue to soar. And SpaceX CEO Elon Musk is determined to make his mark in the sector. But it's imperative that investors tread carefully while putting their money to work. That's why Joel is following one signal that has preceded some of the market's biggest winners in stock market history. And he has stepped forward to share his findings with everyday investors. Before his presentation is gone, hear how you can profit from the next cycle in the AI boom right here.
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LAST CALL for Stansberry Conference & Alliance Meeting Tickets!Our annual conference in Las Vegas is rapidly approaching, and if you don't have your in-person ticket yet, get it today before September 1. You can expect three high-impact days of bold ideas, real conversations, and actionable investing information... plus engaging, fun social events. Across the stage, our top editors and analysts – like Dr. David "Doc" Eifrig, Dan Ferris, Dave Lashmet, Brett Eversole, Josh Baylin, Eric Wade, and more – will reveal their highest-conviction ideas, timely recommendations, and views on today's fast-moving markets... You'll also hear from an elite lineup of guest speakers tackling the biggest forces shaping your wealth right now – from global markets and emerging technologies to alternative investments and future trends. This year's top-notch roster includes tech expert Dan Ives, famed actor and producer Henry Winkler (aka "The Fonz"), CEOs, bestselling authors, PhDs, AI experts, entrepreneurs, and more... Click here to see the full speaker lineup and reserve your seat today. Our conferences are known for blending business with experience – and delivering insights that matter. Past attendees have walked away with ideas and stock picks that could have led to extraordinary gains... There's nothing like being in the room in real time... It's an experience you just can't get from behind a screen. Secure your in-person event ticket right here before September 1. |
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