It’s common for investors to chase stocks with recent strong returns, believing the excitement will continue. This optimism often lacks solid footing, reflecting the greater fool theory—where an investor buys a stock at an elevated price, assuming they can later sell it at an even higher valuation. Consequently, many acquire these “market darlings” at peak prices, only to endure years of underperformance.
This raises a critical question— is piggybacking on past outperformers inherently a flawed or risky strategy? Or can there be a more systematic and discerning approach to identify stocks that are merely at the beginning of a multi-bagger journey—thereby enabling investors to ride the full arc of value creation?
The answer lies in a more disciplined form of momentum investing, where price appreciation is validated by concurrent earnings momentum. When both these elements—market price action and improving fundamentals align, they provide a more sustainable basis for a medium-term rally, unless interrupted by unforeseen macro or micro-level disruptions.
Earnings momentum, in this context, is measured through a range of indicators, upward revisions in consensus earnings estimates, positive changes in analyst recommendations and actual reported earnings consistently exceeding expectations. Stocks that have historically demonstrated a pattern of beating earnings forecasts tend to exhibit a higher probability of delivering consistent performance once a trend is established.
A textbook illustration of this is the performance of India’s leading paint company over the past decade. In early 2014, the company experienced a surge in stock price, underpinned by robust earnings growth, driven by aggressive distribution expansion and increased production capacity. This phase of strong performance persisted for nearly four years. However, between FY17- FY19, the stock's trajectory plateaued as gross margins came under pressure due to raw material inflation—resulting in the stock merely mirroring broader market returns. Subsequently, in post-COVID period, the company saw a resurgence in earnings, particularly due to a surge in home improvement demand, leading to 46% earnings growth and a 132% increase in stock price—double the market’s performance during that period. Yet in last two years, heightened competition and sluggish consumption have dragged the stock down, leading to a relative underperformance.
This cyclicality underscores an important insight— strong and sustained earnings momentum, when followed by corresponding price strength, can be a powerful driver of alpha. Conversely, when earnings momentum fades, price underperformance often follows. Momentum investing allows investors to participate in stocks that are “in form” and exit that fall out of form”—thereby avoiding value traps and consistently aligning with prevailing market leadership.
The key strength of the momentum strategy lies in its ability to adapt dynamically—chasing sustainable earnings momentum rather than anchoring to static valuation metrics or rigid style boxes.
Another advantage of this strategy is its style and market-cap agnosticism. Momentum investing is not confined to any one segment of the market. It offers the flexibility to move across the market-cap spectrum—from large-caps to mid and small-caps—and to navigate fluidly between value, growth, quality or low-volatility styles. This adaptability ensures that returns are not dependent on the outperformance of a single investment philosophy, but instead leverage opportunities across sectors, styles, and capitalization tiers.
Momentum investing demands expertise; identifying sustained price trends and reacting swiftly requires significant analytical skill. Mutual funds offer diversified, professionally managed exposure, simplifying this strategy for retail investors.
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