The other day someone told me “valuation is irrelevant with momentum stocks.” He obviously didn’t realize how stupid that comment was. While momentum stocks can seem to defy valuations and logic for a time, it will always catch up. Momentum stocks are great if you catch the ride up, but if you don’t keep valuation in mind you are playing with fire. At a certain point a stock’s valuation will go from overvalued to just plain stupid, absurd, and ridiculous!
To assume that a stock will just keep going on momentum alone is foolish, perhaps downright stupid. Do you remember the dot com bubble that wiped out a lot of “momentum chasers?” Investors were throwing money at anything that had a dot com on it, regardless of valuation or whether it was making any money or not. Most of those momentum stocks that were making everyone rich, also made them broke when they went under or finally came down to a reasonable valuation. Everyone thought I was crazy around that time when I sold my Microsoft (MSFT) stock in the $50’s (a level the stock has not seen since). What about Yahoo (YHOO), Intel (INTC), Dell (DELL)? What about the countless companies that no longer exist? Many of these companies blew millions of dollars on Super Bowl commercials, but weren’t even around six months later.
Am I saying that momentum stocks are bad or you shouldn’t mess with them? No, what I am saying is that valuation matters, even with momentum stocks! And only a fool would say otherwise. The problem with a lot of “momentum chasers” is they aren’t sophisticated investors and don’t know how to value a stock anyway so they just buy into what’s hot and hope the uptrend continues.
Most investors are either technical investors (or traders) or fundamental investors. I do both, which gives me a huge edge. I don’t like losing money, so I want to eliminate as much risk as possible. What I usually look for is a situation where the fundamentals line up with the technicals, where I like the valuation as well as the technical analysis.
There is money to be made trading and playing momentum, and I am all for it as long as the valuations are not ridiculous. I don’t care how strong the momentum is, if the valuation is way too high I’m not going to touch it. There is easier money to make elsewhere. Remember momentum stocks can drop just as fast as they rise. Don’t be blinded by momentum and start to think valuation is irrelevant. It could come back to bite you in the butt.