Value, Momentum, Quality: What Factor Investing Means and Whether It Works on the IDX
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6 min read
Two stocks cost the same today. One is cheap compared with what the company owns. The other has been rising for a year. Which one tends to do better later?
Researchers have asked this for decades. Their answers gave us factor investing. A factor is a trait that stocks share, such as being cheap, being on a run, or being very profitable. Factor investing means sorting stocks by those traits instead of by name.
This post explains the three best known factors in plain words. Then it asks the harder question: do they work on the Indonesia Stock Exchange (IDX)?
Think of a supermarket. You can shop by brand. Or you can shop by label: low sugar, high protein, low price.
Factor investing shops by label. Each label is a factor, a measurable trait that researchers say helps explain why some stocks earn more than others over long periods.
Three labels come up the most:
A factor premium is the extra return a trait has paid on average. It is an average over many stocks and many years. It is not a promise for any one stock or any one year.
A value stock sells for little compared with its accounting worth. The usual measure is book-to-market: the company's book value (what its books say it owns minus what it owes) divided by its market value (what the stock market says it is worth).
A high book-to-market means the stock looks cheap. A low one means it looks pricey.
In 1992, Eugene Fama and Kenneth French published research showing that size and book-to-market were two simple traits that helped describe the spread of average stock returns. Their later three-factor model, usually dated to 1993, combined the market, company size and book-to-market. Search summaries of the literature say value stocks earned more than growth stocks in that work. I read these summaries, not the original papers.
If you want to see how an everyday version of this works, we explain price-to-book for Indonesian banks in P/B and ROE for bank stocks.
Momentum is the odd one. It says to look at what a stock did over the past few months, not at what it is worth.
Narasimhan Jegadeesh and Sheridan Titman published the classic result in 1993. A Dutch university review of that work says a strategy buying the top 10% of stocks and selling the bottom 10%, ranked on returns over the prior 3, 6, 9 or 12 months, earned between 0.7% and 1.3% a month on average. That covers US stocks from 1965 onward.
Fama and French admitted in 1996 that their three-factor model could not explain this. That is why Mark Carhart added momentum as a fourth factor in 1997.
A word of care. Momentum can reverse hard and fast. Stocks on a run can drop sharply when the mood turns.
Quality is the loosest of the three, because researchers define it in different ways. Most versions look for companies with high profits, steady earnings and low debt.
The idea is simple. A business that earns a lot on its money and does not borrow too much should hold up better than a shaky one. Our post on ROE for Indonesian banks shows one common profitability measure, return on equity: yearly profit divided by shareholders' equity.
This is a fair worry. If a trait pays extra, investors pile in. Then the extra shrinks.
A 2016 study in the Journal of Finance by David McLean and Jeffrey Pontiff looked at 97 traits that earlier papers said predicted stock returns. Search summaries of the paper report that returns were 26% lower out of sample and 58% lower after publication. I did not open the paper itself.
So the honest reading is this. Factor premiums look real in history, but they are smaller once they are widely known, and they can go flat for years.
Here the evidence is thinner and it is mixed.
The most thorough study we found is "Risk factors in the Indonesian stock market" by Nanqi Li, Chishen Wei and Linti Zhang, published in the Pacific-Basin Finance Journal in 2023. It tested 152 factors on Indonesian stocks from 1991 to 2022. According to its abstract, size, value, quality and profitability helped explain future returns. Momentum did not.
The abstract adds that value and size patterns showed up across all stocks. For quality and profitability, the clear signal appeared only among non-Sharia stocks.
Older and smaller Indonesian studies disagree with each other. Search summaries report that one study of the LQ45 index from 2004 to 2007 found price momentum, while a 2016 study of manufacturing firms found it was not profitable. A study of non-financial stocks from 2006 to 2010 found none of value, size or momentum significant. Those studies use different stock lists and years, so you cannot line them up side by side.
Three things stand out.
First, a factor is an average, not a guarantee. A cheap stock can stay cheap for years, or for good reason.
Second, the evidence on the IDX is thinner than in the US. Fewer stocks, shorter history and different studies give different answers.
Third, the traits are not magic. They are another way to ask a plain question: what am I paying, and what am I getting?
Want to see how these ideas look on real tickers?
Open Explore in NetWort and set the market to IDX. Then sort by 3-year return, volatility or Sharpe ratio. The 3-year return column is a rough stand-in for momentum. It is not the 12-month measure researchers use. NetWort does not have a value or quality filter, so Explore will not do a true factor screen. Use it to look at how a run of strong returns came with extra bumpiness. For what the Sharpe ratio means, see Sharpe ratio explained.