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Why Valuations Matter More Than Momentum in Long-Term Investing

Introduction

In the Indian stock market, it’s easy to get excited by fast-rising stocks. A share hitting upper circuits, a small-cap doubling in six months, or a trending sector dominating headlines often pulls investors toward momentum-based decisions. While momentum can create short-term gains, it often fails to protect wealth over time.

For investors focused on Long Term Investing, valuations play a far more critical role than price momentum. Valuations help you understand what you are paying versus what you are getting. Over long periods, this difference determines whether wealth is created or destroyed.

This article explains why valuations matter more than momentum, especially for Indian investors aiming to build sustainable wealth.

Understanding Valuations in Simple Terms

What Are Valuations?

Valuation is the process of determining whether a stock is cheap, fairly priced, or expensive compared to its fundamentals.

Common valuation metrics used in India include:

• P/E Ratio (Price to Earnings)
  
  

• P/B Ratio (Price to Book)
  
  

• Earnings Growth
  
  

• Return on Equity (ROE)
  
  

• Cash Flows and Debt Levels
  
  

In simple words, valuation answers one question:
Is this business worth the price I’m paying today?

Indian Example

If a fundamentally strong FMCG company grows profits at 12% annually but trades at a P/E of 60, future returns may disappoint—even if the company performs well.

What Is Momentum Investing?

Momentum investing focuses on stocks that are already rising in price. The assumption is that “what is going up will continue to go up.”

Momentum is driven by:

• News and narratives
  
  

• Sectoral trends
  
  

• Retail and institutional buying
  
  

• Fear of missing out (FOMO)
  
  

Momentum works well in bull phases but often breaks down when sentiment changes.

Valuations vs Momentum: A Clear Comparison

                     Factor                                                                                      Valuation-Based Approach                                                      Momentum-Based Approach

Focus                                                                                             Business fundamentals                                                                      Price movement

                      Risk                                                                                                   Controlled                                                                                                High

                      Time Horizon                                                                                     Long-term                                                                                             Short-term

                       Margin of Safety                                                                               Present                                                                                                        Absent

Emotional Bias                                                                                     Low                                                                                                                High

                       Wealth Creation                                                                                Sustainable                                                                                                     Uncertain

For Long Term Investing, valuation-driven decisions consistently outperform momentum-driven ones.

Why Valuations Matter More in the Long Run

1. Valuations Provide a Margin of Safety

Buying at reasonable valuations protects your capital even if growth slows temporarily. This concept is especially important in volatile Indian markets.

A stock bought cheap:

• Can absorb bad news
  
  

• Offers downside protection
  
  

• Allows compounding to work effectively
  
  

Momentum stocks rarely offer this safety.

2. Market Cycles Always Correct Excesses

Indian markets have seen repeated cycles:

• Infra boom (2007)
  
  

• PSU banking rally (2010)
  
  

• Small-cap frenzy (2017–18, 2021)
  
  

In each cycle, stocks with stretched valuations eventually corrected sharply—sometimes by 50–70%. Momentum investors suffered, while valuation-focused investors preserved capital.

3. Long-Term Returns Depend on Entry Price

Even a great company can be a poor investment if bought at the wrong price.

For Long Term Investing, your returns depend on:

• Earnings growth
  
  

• Dividends
  
  

• Valuation at entry and exit
  
  

Momentum ignores entry valuation. Over time, this mistake compounds negatively.

4. Valuation Aligns Investing with Business Performance

When you invest based on valuation, you think like a business owner—not a trader.

You focus on:

• Profit sustainability
  
  

• Competitive advantage
  
  

• Balance sheet strength
  
  

• Management quality
  
  

This mindset is essential for long-term success in Indian equities.

When Momentum Fails Indian Investors

Momentum investing often collapses due to:

• Earnings not matching expectations
  
  

• Interest rate changes
  
  

• Regulatory actions
  
  

• Liquidity drying up
  
  

Examples include:

• Overhyped IPOs
  
  

• Small-cap stocks with weak fundamentals
  
  

• Theme-based rallies without earnings support
  
  

These situations highlight why Long Term Investing should never rely only on price trends.

Can Valuations and Momentum Work Together?

Yes—but with discipline.

A smart investor may:

• Use momentum to identify strong sectors
  
  

• Use valuation to select stocks within that sector
  
  

However, valuation should always have the final say, especially for long-term portfolios.

Pros and Cons

Valuation-Based Investing

Pros

• Lower risk
  
  

• Predictable returns
  
  

• Emotional discipline
  
  

• Better downside protection
  
  

Cons

• Requires patience
  
  

• May underperform in short bull runs
  
  

Momentum-Based Investing

Pros

• Quick gains possible
  
  

• Works in strong bull markets
  
  

Cons

• High volatility
  
  

• Emotional decision-making
  
  

• Poor long-term wealth creation
  
  

Common Mistakes Indian Investors Make

• Buying stocks only because they are trending
  
  

• Ignoring P/E and earnings growth
  
  

• Confusing price rise with business improvement
  
  

• Entering late in momentum rallies
  
  

• Expecting short-term strategies to deliver long-term results
  
  

Avoiding these mistakes is crucial for Long Term Investing success.

Valuation Metrics Every Indian Investor Should Track

You don’t need complex models. Focus on:

• Reasonable P/E compared to growth
  
  

• Consistent earnings
  
  

• Healthy ROE and ROCE
  
  

• Manageable debt
  
  

• Free cash flow generation
  
  

These basics are enough for most long-term investors.

FAQs

Is valuation-based investing slow?

It may feel slow initially, but it delivers stable and compounding returns over time.

Can beginners follow valuation investing?

Yes. In fact, beginners should avoid momentum and focus on valuation-first thinking.

Do mutual funds use valuation?

Most successful equity mutual funds in India follow valuation discipline, even when investing in growth stocks.

Should I completely avoid momentum stocks?

Not necessarily. But for Long Term Investing, momentum should never override valuation logic.

How often should I check valuations?

Quarterly reviews aligned with results are sufficient for long-term investors.