The Albert Bridge Factory

I’ve written a lot about the importance of “factors” over the years, and of how appetites for these “factors” are fairly predictable over the very long term, but incredibly time-varying in the short term. I’ve also written about what causes them. Why do momentum stocks have momentum? Why do value stocks (usually) generate higher returns? Is it a risk explanation (aka, an efficient market explanation), or is it a behavioral one? I’ve also stated in blogs and on podcasts that it doesn’t make a whole lot of sense to try figuring out how to time them.

That said, active, us individual stock-pickers can’t bury our heads in the sand and not pay attention to them. Of course, knowing what is happening today might mean absolutely nothing about tomorrow, and predicting the market’s appetite for large caps or growth stocks or high-quality compounders can be a fool’s errand; but at least knowing the paradigm that we are in might be helpful. Maybe there are regimes where things stay funky for longer than they should; almost like a momentum factor for, well, factors?

Moreover, I sure as hell know what I like to own, and to the extent that any of these features are similar to “factors”, then it might be nice to know where our companies stand vs. their peers, or our focus list, or our universe as it relates to fundamental improvement, valuation, business quality, etc.

And maybe what the market cares about matters more in some time horizon than what I care about? Food for thought anyway, and with that, at a very rudimentary level, here is what I care about in my time horizon.

1.       I like companies that are surprising the market by beating earnings. I like to see Mr. Market underreacting to positive changes in a business model. In other words, I like fundamental momentum.

2.       And to the extent that share prices are reflecting this underreaction, I like price momentum too.

3.       I like companies that people don’t already love. It feels like we have more of a tailwind there (exclusive of the price momentum, which usually has an opposite signal). In other words, everything else being equal, I like to be a little contrarian.

4.       I, of course, like stocks to be cheaper than they should be. I like more reward per unit of risk. I like value.

5.       I also like business quality, not in absolute terms, but relative. Is the quality of a business being ignored, or is it shining through. Might the market look upon a business’s quality more favorably next year?  Maybe in two years? This often has an opposite signal than “value”, but when the two work together, it can be magical. In other words, I like undiscovered quality.

6.       Also, as a secondary consideration, I’d rather my companies were less volatile than more. FWIW, this often has to do with capitalization on the balance sheet. In other words, I like low-beta/low-vol.

I think it is fair to say that if we take long positions that are displaying features that are in conflict with the factor exposures above, we’ll have our work cut out for us. So, the bar will need to be higher. Much higher.

Meanwhile, of course, we can’t predict anything going forward, and even when we follow Cliff Asness’ advice and “sin a little” by being naturally overweight momentum and value (for example) I am cool with that. I’m cool with that because that is our process. That is our style. And despite the many short-term headwinds most “value” investors have experienced over the last few years, that is where we’ll have long-term tailwinds.

So, happy hunting; but you don’t necessarily need to bring a Winchester 30-06 and hide in a heavily forested blind all day, you might just want to bring a bow & arrow out to the open plains.