What Works on Wall Street Ch. 4: Trending Value

"The best strategy is to find the cheapest stocks in the market and then buy those with the strongest price momentum." — James O'Shaughnessy

Investment Context

In the book's climax O'Shaughnessy combines the best-performing individual factors into multi-factor models. Value and momentum together produced a synergy that delivered the highest risk-adjusted returns of anything tested across fifty years.

He named the flagship strategy Trending Value.

The Wall Street Translation

Wall Street sorts funds into "value" and "momentum/growth" buckets. Trending Value argues the best position sits at their intersection: buying deeply discounted companies that have already turned upward.

1. Step One: A Composite Value Score

Rank the entire market on a composite rather than any single metric. The score combines price-to-earnings, price-to-sales, price-to-book, price-to-free-cash-flow, and shareholder yield (dividends plus buybacks).

Using a composite rather than one metric is this chapter's key advance over Chapter 2: every single metric has a failure mode — price-to-sales ignores profitability, price-to-book breaks on asset-light businesses, price-to-earnings distorts on one-off items. Cheap on several measures at once is more reliable than extremely cheap on any one.

From this, isolate the cheapest 10% of the market.

2. Step Two: Rank by Momentum

Within that cheapest decile, sort by six-month relative strength.

3. Step Three: Execute

Buy the 25 to 50 names with the highest momentum inside that cheap basket, hold for a full year, then rerun the screen and rebalance.

The position-count requirement is not arbitrary: a deep value basket will always contain names that go bankrupt, and the strategy depends on statistical averages rather than judgment about individual companies. Holding too few lets a handful of failures destroy the result.

4. Why Combining Two Factors Beats Either Alone

The synergy between value and momentum is not coincidence. It arises because they fail at different times.

Value performs worst in late-stage bubbles, where cheap things keep getting cheaper. Momentum collapses at violent reversals, where yesterday's winners become losers overnight. Those two failure conditions rarely coincide, so the combination draws down considerably less than either factor alone.

That is the essence of diversification: not holding more things, but holding things that fail for different reasons. Market Wizards Chapter 1 elsewhere in this library makes the same point — trend following and mean reversion are contradictory yet individually valid edges, and understanding when each fails matters more than understanding when each works.

Actionable Trading Rules

1. Build a two-step screen: First isolate companies in the bottom 20% of the market on price-to-earnings and price-to-sales, then sort that list by six-month price performance and take the leaders.
2. Hold at least 25 names: Fewer cannot support the strategy's statistical premise. This is a hard floor, not a suggestion.
3. Rebalance mechanically each year: Sell what no longer qualifies and buy what does, even when you dislike the companies the screen returns.

Relevance to a Retirement Portfolio

The positioning of this chapter deserves to be explicit: Trending Value is an active strategy, not a foundation for a retirement portfolio.

It requires 25-plus holdings, complete annual turnover, and the capacity to endure years of underperformance. For the great majority of retirees, low-cost broad index funds form the core, and a strategy like this is at most a satellite under 10% of assets, held inside a tax-deferred account.

The next chapter takes up a more fundamental question: how much of these backtested numbers survives contact with the real world.