What Works on Wall Street Chapter 4: Trending Value

"The best strategy is to find the cheapest stocks in the market and then buy the ones that have the highest price momentum." — James O'Shaughnessy

The Investment Context

In the culmination of the book, O'Shaughnessy combines the best-performing individual factors into multi-factor models. He discovers that combining Value and Momentum creates a synergistic effect, resulting in the highest risk-adjusted returns of any strategy tested over the 50-year period.

He calls his ultimate, flagship strategy "Trending Value."

The Wall Street Translation

Wall Street usually separates "value funds" and "momentum/growth funds" into different categories. Trending Value proves that the ultimate sweet spot is the intersection of the two: buying deeply discounted companies that are currently in an uptrend.

1. Step 1: The Value Screen: The strategy begins by ranking all stocks in the market using a composite "Value Score." This score combines multiple metrics: Price-to-Earnings, Price-to-Sales, Price-to-Book, Price-to-Free Cash Flow, and Shareholder Yield (dividends + buybacks). You isolate the cheapest 10% of the entire stock market.
2. Step 2: The Momentum Screen: You take that basket of the cheapest 10% of stocks, and you sort them by their 6-month price momentum (Relative Strength).
3. Step 3: The Execution: You buy the top 25 to 50 stocks that have the absolute highest 6-month momentum from that cheap basket. You hold them for exactly one year, and then you rebalance the portfolio by running the screen again.

Actionable Trading Rules

1. Build a Two-Step Screener: Use a free stock screening tool to replicate Trending Value. First, filter for companies in the bottom 20% of the market in terms of P/E and P/S ratios. Second, sort that list by 6-month price performance. Buy the top 20 stocks on that sorted list.
2. Diversify Your Bets: You cannot run the Trending Value strategy with only 3 or 4 stocks. Because you are buying deep value companies, some of them will inevitably go bankrupt. You must hold a diversified basket of at least 20 to 30 stocks to ensure the statistical probabilities play out in your favor.
3. Mechanical Rebalancing: The strategy only works if you remove your emotions. Once a year, you must sell the stocks that no longer meet the criteria and buy the new ones that do, even if you hate the companies the screener tells you to buy. You must trust the model over your intuition.