We Study Billionaires - The Investor’s Podcast Network - TIP 122 : Momentum Investing w/ Dr. Wesley Gray (Business Podcast)

Starting point is 00:00:00 We study billionaires, and this is episode 122 of The Masters Podcast. Broadcasting from Bel Air, Maryland. This is The Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish and Sting Broderson. Hey, how's everybody doing out there?

Starting point is 00:00:31 This is Preston Pish, and I'm your host for The Investing. and as usual, I'm accompanied by my co-host, Stig Broderson, out in Seoul, South Korea. And we have an exciting interview for you today because we have one of our good friends, Wesley Gray, with us today. And if you haven't heard our previous episode with Wes, you're in for a treat because he is insanely bright and you're going to find that out real soon here as we start asking him some amazing questions. So Wes got his undergrad at Wharton. He He went to Chicago booth. He has a PhD.

Starting point is 00:01:05 He's written four books. Last time he was here, we were talking a little bit more about his book, quantitative value. But today, Wes has a new book that has recently come out. And we talked about this just a little bit on the first episode about mixing momentum investing with value investing. And, Wes, correct me if I'm wrong, but I would say that you have your roots in value investing. Is that a correct statement?

Starting point is 00:01:30 100% correct. I'm a Ben Graham, intelligent investor, Bible thumper originally. I still am to this day. You got it. But so you run in this crowd with Patrick O'Shaughnessy and a couple others. I know James is big on this. I know Toby's big on this. Toby Carlisle, who's in our mastermind group, that you're mixing this value investor Warren Buffett Benjamin Graham approach, but you're slightly mixing. it with a little bit of momentum investing because when you've done all this back testing, you've been able to prove that you can actually get a better result by having this blend. And correct me if I'm wrong, the blend is, you know, off the top of my head. I'm thinking it's around 70% value to 30% momentum. Is it somewhere around in that figure, would you say? Yeah, I mean, it really depends on how you want to slice and dice it.

Starting point is 00:02:22 But the basic idea is, you know, value works, basically overreaction to bad news. momentum works. It's an underreaction to good news. And they're kind of like yin and yang because they're like two religions. So the value guys think momentum's stupid. The momentum guys think value guys are stupid. And so they're actually natural compliments. And if you believe it all in portfolio theory and you understand value investors rightly don't believe in a lot of it. But the basic idea of pooling things that are kind of yin and yang makes a lot of sense. if both things are, you know, high expected return and high volatility, if you can pull those two together and they kind of cancel each other out and, you know, value is doing bad and the momentum's doing great. I mean, that's a good thing from a kind of a risk management standpoint. So before we dive into the first question, so everyone who's listening to this show, this is what this episode is all about. Most of our audience are value investors like Stiggin myself. So we like talking about macro. We like talking about these other things because they're

Starting point is 00:03:27 interesting topics, but at the end of the day, we are hardcore value investors that really don't exercise a lot of momentum investing. So I think that this is going to be a fantastic episode for people out there listening. This is the direction we're going. We're going to be talking about momentum investing and how you can maybe augment or include a small portion of this in your portfolio to increase your returns. And Wes can talk the stats on this. He is a data-driven kind of person. So he can get into the nitty-gritty details of that as we go through the rest of of the interview. Before we jump into the first question, I'm kind of curious where you kind of discovered this approach. How did you come across this, Wes? Well, basically, you know, I start off

Starting point is 00:04:09 doing the value investing thing because that just makes a lot of sense. Like, you know, look at firms as a business, buy them cheap, buy them with margin of safety, etc. Great. And then what's really nice about that kind of story is there's actually a lot of evidence backing it up. And when you look at value investing, you have to ask, well, why does this actually work? And I think we talked about it on the last podcast, but really any investment strategy works to the extent that you can essentially front-run future expectations. So value works because when you buy cheap stuff that everyone hates, it tends to be the case that in the future, expectations tend to get revised in your favor. And by simply buying cheap stuff that everyone hates, you can kind of front-run

Starting point is 00:04:56 that, right? And so now you make sense, the data's there, and from an expectation front-running standpoint, it's a great trade. The whole thing's got a good mojo to it. Well, it turns out that when you look at momentum, it's the same thing. It's all about a way to front-run expectation changes. And so any strategy where you're able to do that, you're going to make money, right? Because value investing will not make you money because if you just buy cheap stuff and no one ever agrees with you, i.e. expectations never change to be in favor of what you think. Like this is a cheap stock, you're just going to always own a cheap stock. Right. And so you always need, even value investors need to rely on the fact that at some point expectations change in the value investor viewpoint

Starting point is 00:05:48 fundamentals matter. So eventually it'll drag the expectation that direction. but that's an assumption that expectations will go to that. And it turns out to be a good assumption. But I think that same sort of logic of, okay, how are we going to front run other market participants get ahead of that game? Well, momentum tends to be a great signal to do that. And arguably, well, it's not even argument. Like the data is more strong for momentum than value.

Starting point is 00:06:17 Just from a straight, like, evidence-based standpoint. Perfect introduction, Wesley. And before we dig into the first question, we probably said that a few times before we dig into the first question. I just want to add one thing more, guys. Wes you were on episode 48 and 49, and we'll make sure to link to those episodes in the show notes. Because we talked a few times about, well, you've been on a podcast before we discussed some of it. But we definitely see this episode as a continuation of those episodes. But clearly we're also going to talk about some of the standard elements and explain the concept.

Starting point is 00:06:49 in this episode as well. But Wes, I would like to turn the very first question into a brief history lesson. So in your new book, quantitative momentum, you described the birth of technical analysis and you talk about how it was developed in the Netherlands later in Japan and how billionaires like John Soros and Drunk Miller and Paul Tudor Jones later have become very successful with the approach. Could you please take us back in history and talk about the modern technical analysis approach? Sure. So, I mean, I can only take you back as far as documented history that we could find will take us.

Starting point is 00:07:27 You know, we get back around the 1600s. I talk about, you know, De La Vega where he's in the Netherlands there. You know, he's basically mentioning behavioral finance, how people participate in markets. And a lot of times it's all about the technicals. And, you know, it all boils down to what my old roommate tells me. High prices attract buyers, low prices attract sellers. And this guy's retired already and we're not. And he was a market maker at Deutsche Bank for like 10 years. And he's basically explaining momentum. And so I think this is something that, you know, you can look way back.

Starting point is 00:08:03 A lot of people have been doing this for a long time. And what's interesting is when you start getting into formalized research, you know, it's like anything. There's always like it seems like there's a dark age. So momentum in the specific application that we talk about. in our book and what is under discussion here is using momentum to select stocks. This idea, you know, was originally taught like Gary Antonoshi talks about the Colton Jones paper in 1937. You know, it's kind of more of a trend fall thing, but kind of hints on momentum.

Starting point is 00:08:37 1937, okay, that was a long time ago. Robert Levy, 1967, publishes a paper on relative strength strategies in stocks in the Journal of Finance for God's sake. The top chair academic journal. Okay. What happens also about that time? Well, Eugene Fama publishes his dissertation in 1965 and all of a sudden you get the efficient market mafia kind of starts controlling the thought.

Starting point is 00:09:07 It's all about math. It's all about modern portfolio theory. This 1967 paper that basically shows that you can just use simple price patterns to basically beat the market. You know, these guys get buried. And they're not allowed to basically talk for another 30 years. And then you got Jigdison Timman, 93, who a lot of people say is like, quote, unquote, when momentum was found. Well, I just talked about a paper that was published 30 years prior to that. And another paper published 30 years prior to that even.

Starting point is 00:09:39 And so everyone's been saying, oh, momentum's a new thing. It's going to get armed out now that everyone knows about it. You know, recently everyone's been saying, oh, momentum's dead. Well, there's my old boss, Chris Gatesy, has a paper where they got data from 1800 to 1927, so basically 120 years out of sample data. And guess what? Momentum works just as well then as it did in the last 100 years. However, just like value, you get your face ripped off sometimes. And that's why it worked.

Starting point is 00:10:09 So, Wes, without jumping into, you know, questions later on, for a person who's hearing that response, I think the, the thing that immediately jumps into your head is how do you protect yourself from that event that you just described as being just totally cataclysmic event as you're implementing this momentum strategy and it just totally does not work. How does a person mitigate that risk from happening? Sure. So the best way someone described momentum investing, Timmy was actually from a value investor, this guy, Charles Mizrahi, he says, momentum investments like this. Value investing, you drive in slow, boring car in the slow lane. You kind of grind it out.

Starting point is 00:10:52 You know, the Ferrari's past you by and you always look stupid. You know, a lot, you kind of grind it. Sometimes your car breaks down and you're screwed and you lose a lot of money, but whatever. It's just kind of a grinder strategy. Like, momentum is basically a strategy where you're always in the fast lane going 100 miles an hour and the minute that lane ahead of you start slowing down, you switch lanes. Like values kind of a long-term, hold, grind-it-out type strategy. Momentum, necessarily, it's momentum.

Starting point is 00:11:25 So the minute something starts losing momentum, you got to get out of that thing, get out of that lane because you're going on a mile an hour. So it's just a total different way of an approach. But that's how you protect yourself in momentum is the minute there isn't momentum, get out and move to what has momentum. And that tends to historically give you a lot of bang for the buck, has a lot of vol, just like value. But you're not just like riding these things down to zero because mechanically you're going to get out and move the high momentum. And when we talk about the things you're really paying attention to, it's all price action, right?

Starting point is 00:11:59 It's just all the price that's being paid for the security, nothing else. Yeah, and that's a proxy for what a lot of people argue is related to fundamental action, basically underreaction. So like guys can basically map, there's a Novi Marx paper that does it essentially where if you look at earnings releases, right, there tends to be for a reason like underaction these earnings releases. So people release unexpected positive earnings. You'd expect the stock to move to the quote unquote fundamental value. It never does. It moves up and then it kind of drifts. Well, you know, momentum is a way just using the price. You essentially capture that as well. But people can map prices, the price appreciates. to fundamental releases of information that for whatever reason, anchoring biases, what have you, like the market just doesn't react fast enough for some reason. It's unclear why that is, but it just it is. So even though you use price as the proxy or returns, it's not like it's just, that's it. A lot of times does map back to like a fundamental element there, which is basically

Starting point is 00:13:06 underreaction to good news. It was, I think, what most evidence suggests. And just very briefly for people out there listening and thinking, I heard about this, I have a really good understanding of value investing as. Could you just briefly explain momentum investing? It's like, if you have a stock called it $10 and it drops to $5, as a value investor, you would be thinking, hmm, this might be now trading at a lower price. There might be some value there I can gain.

Starting point is 00:13:30 Whereas that's not what you're looking for at all as a momentum investor. If you're looking for that stock going from $5 to $10 and saying that there might be, be a strong indication that it might continue. Is that basic what you're saying? Yes. So value investing, you know, in traditional sense, is basically buy cheap stuff, right? And that's great. Got it.

Starting point is 00:13:48 Momentum investing is basically by relative strength. So when we talk about stock selection, there's two types momentum. There's, you know, kind of trend-falling momentum or what they call time series momentum. That's like looking at a stock at a current point in time relative to its history and making a decision based on that. So it's in isolation. What we're talking about here, the geek term is called cross-section momentum or the practitioner term is relative strength.

Starting point is 00:14:15 So here, we don't really care if you're up 10% or even down 10% as long as you're relatively doing well to other securities in your universe. So if you're negative 10, but the other guys are negative 50, the evidence is pretty clear that the negative 10 guy will continue to have strong relative performance than the negative 50 guy. But it's not about just, we're talking about the absoluteness of it is not what we're looking here. It's the relative momentum that is really the documented effect as far as stock selection. Now, when you say relative momentum, relative to other companies in that industry is what you're comparing them to? Yeah, you can do that. Or you can just do it across all securities.

Starting point is 00:14:58 People do it within industry. It doesn't matter. But as long as it's in the relative is what matter. So as long as you have momentum relative to whatever universe you're operating in, that is the signal that seems to, you know, kind of drive this empirical phenomenon that's been around forever. Very interesting. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom

Starting point is 00:15:39 Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists,

Starting point is 00:16:13 policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience powerful mainstage talks, hands-on workshops on freedom tech, and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June. If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedom Forum.com

Starting point is 00:16:43 with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference. It's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful in the real world?

Starting point is 00:17:04 Because the upside is huge, but guessing your way into it is a risky move. With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR, and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the NetSuite AI connector, you can use the AI of your choice to connect directly

Starting point is 00:17:40 to your real business data. This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide, de mystifying AI at net suite.com slash study. The guide is free to you at net suite.com slash study. NetSuite. com slash study. When I started my own side business, it suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting,

Starting point is 00:18:18 but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the U.S. from brands just getting started to household names. It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support.

Starting point is 00:19:01 Start your business today with the industry's best business partner, Shopify, and start hearing sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right, back to the show. So, Wes, could you explain the concept of behavioral finance and why it hints at the framework for being a successful active investor? And I know in your book, you provide a poker analogy. So could you kind of give our audience a glimpse of that?

Starting point is 00:19:39 Yeah, sure. And so this framework, which I'll outline to you guys, we call it the Sustainable Act Investing Framework. This is a framework through which you can review any strategy, value investing, momentum investing, Ouija board investing or whatever. The idea is if you can't map it into this framework and identify the edge, it's not real. It's data mining. So essentially the way it works, and this is really just academic behavioral finance, but most people think that behavioral finance is about behavior.

Starting point is 00:20:12 So understanding how investors have all kinds of weird psychology problems, they make bad decisions, and then they do stupid things in the market. But that's not really interesting because if it was only about behavior and if there was one really smart person, they would just go get billions of dollars and exploit all those people. And it wouldn't matter because they would just arbitrage them away like ASAP. But in order to make behavioral finance interesting, you need to identify one, decision making errors. So why do people do stupid stuff in the first place and sell stocks too cheap or whatever? but then also why in the hell aren't the arbitrage guys taking advantage of it? Because only then we actually see these effects in the data.

Starting point is 00:20:57 Because if it's driven by a behavioral issue and then we also understand the market frictions or why other smart people aren't doing it, now we have like a real effect that we can actually see in the data and try to understand it. And so essentially what the Sustainable Active Framework suggests is we got to answer two questions. Whenever we're doing any sort of long-term investment strategy, they purports to have any sort of edge over just buying a vanguard fund, which is amazing, right? Because it's cheap, tax-ficient, and you own everything. Incredible.

Starting point is 00:21:28 The first question is, you know, I'll use the poker table analogy. Who are the bad poker players at this table that I'm sitting at here? And that's where we get into the behavioral stuff, right? Like, who's the idiots that are, you know, selling these great companies that crazy PE ratio? because they've got overreaction biases or representedness or whatever it is. We need to identify what is the underlying psychological problem with people that are investors out there making decisions because that's going to create this sort of initial mispricing. So you've identified the bad poker players at the table, but we don't operate in a world

Starting point is 00:22:10 where it's only bad poker players. We operate in a world where there's people with PhDs and physics and math, people that got 30 years of stock picking like Warren Buffett type. So we need to understand what are the best poker players at the table doing. And if we identify situations like value investing, we kind of understand the behavioral reasons of why these opportunities exist. You know, it's really hard to do. It's really painful strategy. That's great because the best poker players have a friction. They can't just easily exploit this.

Starting point is 00:22:44 And so value works like that. Let's think about momentum. Well, value, the core behavioral bias, arguably, is overreaction to bad news, right? People throw the baby out the bathwater. You know, that's a simple way of saying it. Great. Why don't the best poker players do it? Because it's painful as hell and all lose their job, right?

Starting point is 00:23:03 Who wants to do that if you do like active value investing? Well, what's momentum? Arguably, the behavioral bias there is this is an underreaction. to fundamental good news that price signals are telling us. In fact, they're yelling at us that this is the case. And yet people underreact to that price signal because they're overconfident in their own information set. So that's kind of the one of the core leading theories about the behavior that drives momentum. And then, well, why don't all the best poker players do it?

Starting point is 00:23:33 Well, just like value, if you do momentum strategies, you are going to look like the biggest idiot in the entire planet for potentially five, 10-year stretches. That's great because that means it's sustainable. You can't be like a prop shop, lever the strategy up and arbit away immediately. And so bottom line is those two questions. Who are the bad

Starting point is 00:23:55 poker players? Great, we need that because they cause mispricing. Second question, why isn't Warren Buffett or why aren't like all the other smart people managing billions of dollars doing it? If we understand their limitations, now we have a real kind of sustainable opportunity.

Starting point is 00:24:11 And I just, of the belief that value and momentum fit in that framework pretty effectively. Very, very interesting, Wes. And I think this is a really good transition into the next question. Because one of the ideas that I got from you by following your research and reading your blog and your work is that you have explained about an investment style box or if I should just explain this. So traditionally, when we have an investment style box, it's usually a thing. 3 by 3. So it's divided into 3 rows with big, mid, and small cap, and then 3 columns with

Starting point is 00:24:48 value, blend, and growth. And this is like the way that we usually see this box. So whenever we are looking at an ETF, for instance, it will be in one of those nine squares in terms of explaining what time of ETF it is. Now, you suggest that perhaps we should replace growth with momentum. Could you please explain why we might need to rethink growth and replace it with momentum in the future? Sure. So it depends on your objective function. If you're trying to closet index and minimize tracking error, growth is great. If you're trying to maximize expected return and play the buckets that the evidence suggests will actually generate excess return over long.

Starting point is 00:25:37 periods of time. You don't want to think in terms of growth because growth without momentum is a sucker bet. It's what every value investor in the world knows is a bad idea. Overpaying for hype, you know, buying the latest, greatest scheme out there that the streets pump in the newest IPO, like basically expensive stocks, right? That we already know, all value investors know, total sucker bed. But momentum is not growth or it is not expensive stocks. Momentum is momentum is, what is your performance relative to other securities in universe, independent of fundamentals, right? You could be a high flying 100 PE stock and have high momentum. You could also be like recently, because you guys probably appreciate this like I do, small cap value has been face

Starting point is 00:26:32 ripping, rocking. A lot of those stocks are momentum right now. So you could actually have a circumstance right now where you can be value and you could be momentum. But the key is you don't want to buy expensive stuff, which is growth. What you want to buy is you want to buy value and then momentum, where momentum is high relative strength, not growth where growth typically means expensive hunter PE securities. Momentum can be that, but doesn't necessarily have to be that. It's So the idea is if you want to maximize expectation and not just worry about trying to cover all the buckets of the market, you know, value is one area you want to focus and momentum is another. And those are the two spectrums you want to be in, or at least from what the evidence suggests,

Starting point is 00:27:18 if you actually care about, quote unquote, trying to beat the market or generate risk premiums in excess of just, you know, buying the Vanguard fund. So, Wes, I'm curious if you could dig into a little bit more defining the difference between growth and momentum because I think the typical person listening right now, they haven't made that difference yet. So let me just try to put it in my own terms and then you kind of self-correct off of what I'm saying here. So when you're talking growth, you're talking about call it like an Amazon company where you're looking at the top line revenues, you're seeing them grow at a rapid pace, and you're expecting that to just go off into oblivion and just keep shooting into

Starting point is 00:27:57 the stratosphere, that would be more of what we commonly refer to as a growth pick. Now, when you're talking about momentum, you're really looking at just the price action of the stock. So let's say it's Amazon again. And you saw compared to other tech companies or, let's just say the S&P 500 in general, you're seeing that price action and it's moving twice as fast as any other stock out there. We would label that momentum. Is that a correct interpretation of this? And if not, just kind of hit the delta. Yeah, yeah, that's really good. And let me go really slow here because this is like a nuance point that matters so much.

Starting point is 00:28:35 So let's go back to the value anomaly as it's documented. It basically says, let's just take PE ratio. We got a thousand stocks. The value anomaly basically says that if we simply buy the cheapest 100 and we compare the performance on that to the most expensive 100, you get this huge spread, depending on the size cuts or whatever. Let's say it's 5% or anywhere from 2 to 8% depending on what the size levels are. But it's huge, right? That's a massive difference over 100 years, a 2 to 4% kind of spread.

Starting point is 00:29:12 The low PE stocks are called value in academic research. The high PE stocks are considered growth or glamour or what have you, right? Got it. Momentum says, we're not looking at any E. We're looking at P. That's it. And we're not only looking at P. We're looking at how P compares to the other P's in the market,

Starting point is 00:29:35 i.e. P is the price. So with momentum, you say, okay, now we've got a thousand stocks. We're going to rank them on their last one-year performance. And we're going to sort them. The top 100, they're going to probably have, you know, 50%, 60% returns. The bottom 100 are going to have probably whatever, negative 10, negative 20. the spread between those top 100 and those bottom 100 is like double value premium. So if value, depending on how you cut the size is two to four, you know, momentum is going to be four to eight.

Starting point is 00:30:06 So just the absolute spread there is different. And the key differentiation is growth is about P to E. Expensive stuff. Momentum is about relative strength price movement. And that little difference matters so much. have a growth stock, i.e. a expensive security, if it doesn't have momentum, it's got a bad expectation. If that security has momentum, but it just happens to be also an expensive stock, you have a good expectation. And that little nuance is all the matters. And you hit it right

Starting point is 00:30:43 when you said Amazon. Amazon, you know, expectations off the wall, like right now, I don't even know what the PE is. It's probably like infinity, but it's also being it's face ripped. So it doesn't have as much momentum as it used to have. So that's becoming less attractive to a momentum investor. But go back six, seven months ago, Amazon still has a P.E. of an infinity. But who cares? It has amazing momentum. So it's that momentum characteristic that drives us.

Starting point is 00:31:12 And it's independent of the valuation. It's a total kind of different way of thinking than value investors typically think. Fantastic. Which is fine. Yeah. No, that clears it up. It's crystal clear when you describe it that way. Now, I'm just kind of curious on this, Wes, because I know you're a huge quant guy.

Starting point is 00:31:30 You are all about the numbers and going back and back testing and all that kind of stuff. So I'm kind of curious what the average duration that you would, if you had a basket of call it 100 momentum picks over a certain amount of time, how long were you holding on to these picks on average? What would you say that that number is? Well, I mean, in order to get it to work, it's way higher turnover, three to four times. three to four times. So value, here's some basic empirical facts. You take a value strategy, right? Let's just say low PE just for ease here. So we're just going to be Ben Graham, buy cheap stocks low P.E. If I go buy the cheapest hunter stocks right now, and if I five-year rebalance that, I still got some edge. If I one-year rebounce that, I got a lot more edge.

Starting point is 00:32:17 If I quarterly rebalance, I got a little more edge. And if I month to rebalance, I got a lot of it. And you can go crazy on it, right? But value, you could hold that for five years out and you're still going to have an edge. Momentum is like I saying, you're driving a fast car. And if that fast car has a wreck in front of it, if you don't change lanes, you're dead. Right? So momentum, you have to turn that thing over and rebounce that portfolio quarterly to,

Starting point is 00:32:46 to frankly get any of the benefits of it. And it's just the nature of it. And if you do it monthly, it's even better, which means that momentum, while way more compelling, is also way more trading intensive and arguably has a lot less scalability to it than value.

Starting point is 00:33:02 Because value, as I mentioned, you could buy stocks and home for five years and capture some of the edge. In momentum, you have to trade it at least quarterly. In your turnover, I'm just going to throw it out there, but maybe you get,

Starting point is 00:33:16 200% a year turnover were maybe a value strategy, depending on how fast your rebounds, it may be half that or a quarter of that. It's just the nature of the two anomalies. They're just vastly different. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customers, Trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing

Starting point is 00:33:58 spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Riter spend 82% less time on audits with VANTA. That's not just faster compliance, it's more time for growth. If I were running a startup, or scaling a team today, this is exactly the type of platform I'd want in place. Get started at vanta.com slash billionaires. That's vanta.com slash billionaires. Ever wanted to explore the world of online trading, but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&P 500, NASDAQ, Bitcoin, gas, and much more.

Starting point is 00:34:49 Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity. You'll be able to trade it in just two clicks once your account is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited risk-free demo account with charts and analytic tools for you to practice on.

Starting point is 00:35:22 With over 20 years of experience, Plus 500 is your gateway to the markets. Visit Plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus. Billion dollar investors don't typically park their cash in high-yields, accounts. Instead, they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes

Starting point is 00:35:57 thanks to the Fundrise income fund, which has more than $600 million invested in a 7.97% distribution rate. With traditional savings yields falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Fundrise.com slash WSB to invest in the Fundrise Income Fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income fund's prospectus at Funds.

Starting point is 00:36:44 RANDRISE.com. This is a paid advertisement. All right. Back to the show. So, Wes, so a person hearing this, like my immediate thought, when you hear that the turnover is higher, which is what I totally expected, I think I'm going to be paying taxes through the nose. So how can I invest in an ETF or a fund where somebody's actively managing this, but I buy

Starting point is 00:37:08 it once and I, let's just say that I incorporate this as a 15% position in my portfolio, so that I don't have to be doing this buying and selling and paying all the taxes that are associated. Yeah, so there's two schools of thought on that. I mean, one of the things that's actually unique about a momentum strategy, even if you didn't have any special tax wrapper on it, is you know, you're buying the winners and basically cutting the losers. And so you're mechanically always booking capital losses.

Starting point is 00:37:35 And then a lot of times you're letting those winners ride. So you do have a lot of turnover, but you can't have names that, you know, end up being 10xs. you hold them for five years. So there is some tax efficiency innate to momentum, or at least not as bad as one would think at the outset. But of course, as you mentioned, and it is intuitive, because of that training activity, you are going to generate a ton of capital gain liability. So you need to find structures. Like, you know, obviously we like the ETF structure because it allows us to internal to that structure, avoid capital gain distribution. So, you know, a buy and hold investor or can basically access that turnover

Starting point is 00:38:13 without having to eat in 1099 distributions every year. You can also use in qualified accounts. And if you're really rich, there's all kinds of other schemes you can do. But 100% agree. If you're going to do momentum and you're a taxable person, you need to wrap it in a tax vehicle.

Starting point is 00:38:30 And the ETF is probably the most accessible one for not billionaire types. So this part of time in the show, we would really like to respond to one of the questions from the audience. And Wes, I know that we're really putting you on the spot here, but I really hope that you would like to help Preston me out with this question. Does that sign good? Yeah. I mean, our mission is

Starting point is 00:38:50 in power investors for education, so send it on down. All right. So our first question comes from Brian Kirby. Hi, sticking Preston. This is Brian Kirby from New Hampshire. Thanks for all the work you put into the podcast. I'm new to value investing. Over the past year, I've been trying to accumulate as much knowledge as I can on value investing, investing in individual companies. Your podcast has been very key in that journey. I'm starting to look at individual companies and their 10Ks. What sections of the 10Ks do you feel are the most important? Thank you. All right, Wes, you take it away. If we're talking about value investing and we're talking about 10Ks, there's a few areas you want to look at. One, you want to first figure out what the heck the price is,

Starting point is 00:39:36 which isn't in the 10K. But after you do that, we're big fans of operations of operations. We're a big fan of operating income or kind of, you know, measures of profitability that are a little bit further up the income statement, not net income because it can be games a lot. Another thing you want to focus on, there's actually a really cool paper about this. I'm a quon kai, so I'll give you a quenquant perspective. What some researchers did is they actually look at 10Ks and they machine read them because for, you know, 99% of them are templated. What they did is they said, hey, all these lawyers, they make you write this templated language.

Starting point is 00:40:09 But what happens when the template language changes? And specifically, is there certain sections of the 10K where when the language changes, it really matters the future performance. And one of those is actually in risk factors. If you just look at the temperate language and risk factor section and you do it year over year, quarter over quarter, however you want to do it. And again, I recommend doing a computer, but if you don't have a computer, you can do it by hand. And whenever you start seeing additional risk factors list in there, i.e. the lawyers are like,

Starting point is 00:40:41 guys, we need to kind of cover our ass here. And we don't want to talk about this publicly, but this is our disclosure document. So we need to legally disclose this here. But, you know, because obviously they're not going to make this front and center on the conference calls. But I would focus on that risk factor section. And don't just read it absolutely. Read it relatively. Read it relatively to what they've said in the past. If you all of a sudden see a whole addition of risk factors. That's like a momentum way of seeing the relative change

Starting point is 00:41:10 in a tech. Yeah. I mean, it's crazy, man. These guys use a computer to literally like machine read and they look for these changes. And risk factors is where a lot of these CEOs like a bury information

Starting point is 00:41:24 that's super relevant to market expectations, but because obviously they're CEOs, they don't want to like talk about these things or emphasize them. So a lot of times it kind of goes to the wayside, but it's highly predictive of basically poor performance. Because that is so true. You know that they'd have the lawyers just adding all sorts of that.

Starting point is 00:41:44 That is so smart. And I've never heard that before. I really liked that comment. That was amazing. I'll give you one more that's also just kind of varsity level, fundamental. But there's another thing you do is like customer supplier relationships. There's an old trading strategy where, you know, basically in those 10Ks, you got to disclose over 10% revenue partners.

Starting point is 00:42:04 And obviously, like, let's say Stig, and there's a classic example is golf clubs. So Stig is Calloway Golf, and I'm like a head supplier for golf clubs. If all of a sudden you want to follow Calloway Golf, if you come out and Stig says, dude, my sales are horrific, and you're analyzing me, the company that's making the golf heads, because I'm going to report in like a month or so, you know, and I know that Stig is 80% of my revenue, I might want to consider the fact that Stig just said his cell. are abysmal because that is going to affect me a lot. And what you do is you get these customer supplier price reaction lags where you have information

Starting point is 00:42:44 in the marketplace on another company that is economically linked to the company you're investigating, but you may get blindsided if you're just looking at the 10K in isolation, but not considering like the ecosystem. So that's another trick that a lot of like kind of varsity fundamental guys like to do. They kind of like to understand the. ecosystem of what other guys are releasing. Yeah, and just something to add to this because, Brian, I really think this is a great question. And you're starting with the 10Ks because most investors, like even with years experience, they never go that far.

Starting point is 00:43:18 So that's really good. One thing to say about this is that reading 10K is really an art. Like, you need to read quite a few really to get a grasp on this. I remember one of the first times I was reading this risk section. And I was like, hmm, I need to go through and read all the different types of risk. and it just seemed so generic. And guess what? Like a lot of the risks that you do read about,

Starting point is 00:43:40 they're extremely generic. It's something like, oh, if we can keep up with customer preferences, it's a problem for us. And I mean, try if you see if you can find a business in the world that doesn't need to keep up with customer preferences. I mean, a lot of this is completely useless.

Starting point is 00:43:56 And I think in general, you need to think about that whenever you're reading, not only the risk section, but basically all the sections and the 10K. And the same goes for the management discussion. How sincere is it? Is it completely generic?

Starting point is 00:44:09 Did they have someone from the PR department basically write that out? Or are talking about mistakes actually making? I were talking about the key drivers of the industry where they are in the cycle. I mean, that's the things you should be looking for because the requirements for 10K in many ways they're really strict because all of this is regulated. But in a way, it's also very easy to get away with a lot of generic, useless talk. So if you can diagnose if it's sincere, in a lot of better words, this is a trickle-down effect you see from the management and the rest of the organization. I know that this is really the art part that I'm talking about because how to determine that,

Starting point is 00:44:46 but if you get the impression that they're trying to hide something from you relating to back to what Wes said before, hmm, they just suddenly got 15 new risk factors. Then you probably should run away as fast as you can. Well, I've got a question for Wes because he was talking about this a little bit at the beginning of your response, Wes, about the operational income. So are you really big on really kind of going to the cash flow statement and looking at the operational income and then, you know, subtracting your CAPX to come up with your free cash flow? Is that what you're really seeing is the real earnings here?

Starting point is 00:45:18 Well, you know, free cash flow is a little bit difficult because CAPX is all over the place. What I was suggesting is just move up the income statement. So at the top, you got the revenue. And then, you know, after your cogs, you got like your gross profitability, rip off some SGNA. You know, you're starting to get to like your EBIT kind of and then pull off some depreciation, amortation, get the EBIT. Just all those are good. I mean, honestly, if I was just starting off value investing, whether I was a professional or not, I mean, because it's what we do. We focus on operating income, which essentially, you know, EBIT.

Starting point is 00:45:55 And then we look at total enterprise value, which essentially like a price. And we just buy the cheapest ones. Preston and I recently did an interview with Bill Miller. He's basically saying the same thing. He said that if it divided by intrepresent value, that's really the indicator that you would go for. But Wes, I'm just going to throw it over back to you because I see you have another point here.

Starting point is 00:46:18 What does Warren Buffett do? I think he reads market psychology. And whenever he sees a firm, well, we already know what he does. Like, Prasini and those guys wrote a whole paper about it's called Buffett's Alpha. And we know quantitatively what he does. He buys cheap. He buys quality and he buys what they call low beta. Let's just punt that.

Starting point is 00:46:39 Systematically, effectively what Buffett does in his computer brain that none of us actually have, but he does. He's just buying cheap stocks that are high quality. Key is cheap and the key is quality. And all I think he does, he sits back and waits. Oh, IBM. Yeah, they're getting their butt kicked. by Google and yeah, they're not going to become like Google, but we don't need to become Google. They're a great firm and we just need them to do better than expected at the current price.

Starting point is 00:47:09 And so all the positions he starts taking on, I think he just sits back and waits for the psychology to turn. He's earning his chops by focus on market psychology, buying when everyone else thinks it's a stupid idea, and then just holding no matter what, even though he may look like an idiot in the short run. All right. So, Brian, thank you so much for submitting your question. We really had fun answer in that. For anybody that gets your question played on the show, we're going to give you a free

Starting point is 00:47:37 subscription to our Intelligent Investor video course where Stig goes chapter by chapter, step by step, teaching all the important lessons inside of the intelligent investor. So Brian, you get a free subscription to our video course. So thank you so much for submitting that. And Brian, you're also going to get the TIP Academy course, How to Invest in ETF. which is a process by step that we outline for you. So if you guys are enjoying our conversation with Wes, make sure you guys tune in next week because we have the second part of our interview

Starting point is 00:48:10 where we continue this dialogue with Dr. Wesley Gray. And I'm telling you, you're definitely going to want to tune into that because we really get into some interesting conversations into the second part. So Wes, I want to give you a quick opportunity. If people want to learn more about you or see some of your content, give them a handoff to where they can learn more about you. Sure, the easiest place to do it is just go to alpha architect.com. And I'm sure you guys will link to it in the show notes.

Starting point is 00:48:36 That's where we live on the internet. And I also want to highlight your new book, quantitative momentum. If you're enjoying this conversation, I know for me, this is challenging a lot of my preconceived notions of investing because I'm a hardcore value guy. But if you want to learn more about this,

Starting point is 00:48:53 you've got to check out his book. I guarantee it's going to be one of the, the best books you read on momentum because it's based on data. It's based on back testing that Wes has done. And that's something that I don't necessarily think you're going to find in a lot of books that are written about growth, which this isn't growth. And I think we've kind of dispelled some of that. But more on the momentum side, he backs it up with data and hard facts. So I can't help promote Wes's work highly enough because it's something that will really help people challenge their way of thinking, especially if you come from a value investing background.

Starting point is 00:49:27 That was all that we have for this week's episode on The Investors Podcast. We will see each other again next week. Thanks for listening to The Investors Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www. www.com. Submit your questions or request a guest appearance to The Investors Podcast by going to www.com. If you're question is answered during the show, you will receive a free autographed copy of the Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before a commercial application.

We Study Billionaires - The Investor’s Podcast Network - TIP 122 : Momentum Investing w/ Dr. Wesley Gray (Business Podcast)

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.