The Twin Momentum strategy, based on research by Dashan Huang and his colleagues, represents an innovative approach to momentum investing that combines both fundamental and price momentum factors. This dual approach was found to generate significant outperformance compared to using either type of momentum in isolation.
The Strategy’s Foundation
The academic foundation for this strategy comes from Huang’s research, which demonstrated that combining fundamental momentum indicators with traditional price momentum could lead to enhanced returns while potentially reducing risk. The fundamental momentum component looks at seven key variables:
- Earnings
- Return on equity
- Return on assets
- Accrual operating profitability to equity
- Cash operating profitability to assets
- Gross profit to assets
- Net payout ratio
The price momentum component examines the twelve-month return excluding the most recent month, a timeframe that academic research has shown to be most effective for momentum strategies.
Strategy Criteria
Validea’s implementation of the Twin Momentum strategy uses three main criteria:
- Fundamental Momentum: Companies must rank in the top 20% of the universe based on a composite of the seven fundamental factors. This identifies firms with strong and improving business fundamentals.
- Twelve Minus One Momentum: Stocks must rank in the top 20% based on their eleven-month return (excluding the most recent month). This helps avoid the short-term mean reversion that often occurs in price momentum strategies.
- Final Ranking: Companies are ranked based on the combination of their fundamental and price momentum scores, with only the top 5% qualifying for the strategy.
Benefits of Twin Momentum
The Twin Momentum approach offers several advantages:
- Reduced False Signals: By combining fundamental and price momentum, the strategy helps filter out stocks that may have strong price momentum but deteriorating fundamentals, or vice versa.
- Enhanced Validation: Strong performance in both fundamental and price momentum provides multiple confirmations of a stock’s momentum.
- Risk Management: The fundamental criteria help ensure that price momentum is supported by improving business performance, potentially reducing the risk of momentum crashes.
Top-Scoring Twin Momentum Stocks
Here are five companies that currently score highly according to Validea’s Twin Momentum strategy:
CAL-MAINE FOODS (CALM) Score: 100% A leading producer of fresh shell eggs, CAL-MAINE FOODS excels in both fundamental and price momentum metrics. The company’s fundamental momentum ranks in the 1st percentile while its price momentum (81.44% return) ranks in the 11th percentile. The combination of strong earnings growth, improving profitability metrics, and significant price appreciation makes it a perfect fit for the strategy.
HOWMET AEROSPACE (HWM) Score: 100% This aerospace and transportation industry supplier demonstrates exceptional twin momentum characteristics. Its fundamental momentum score places it in the 1st percentile, while its price momentum (113.05% return) ranks in the 7th percentile. Strong operational improvements combined with robust market performance support its high ranking.
ONTO INNOVATION (ONTO) Score: 100% A provider of semiconductor manufacturing solutions, ONTO INNOVATION shows strong momentum across both dimensions. The company’s fundamental momentum ranks in the 1st percentile, complemented by price momentum of 68.79% ranking in the 13th percentile. Improving semiconductor industry dynamics and strong execution drive its high score.
TECNOGLASS (TGLS) Score: 100% This architectural glass manufacturer demonstrates exceptional twin momentum characteristics. Its fundamental momentum ranks in the 1st percentile, while its impressive price momentum (129.45% return) ranks in the 6th percentile. Strong execution in its core markets and improving margins contribute to its high ranking.
ENERPAC TOOL GROUP (EPAC) Score: 100% A provider of industrial tools and services, EPAC shows strong momentum across both fundamental and price dimensions. The company’s fundamental momentum ranks in the 1st percentile, while its price momentum (51.52% return) ranks in the 20th percentile. Operational improvements and market share gains support its high twin momentum score.
The Twin Momentum strategy represents a sophisticated approach to momentum investing that looks beyond simple price momentum to incorporate fundamental business improvement. By combining these two forms of momentum, investors can potentially identify companies with sustainable momentum that’s supported by improving business fundamentals. The strategy’s dual focus helps filter out stocks that may have unsustainable price momentum while identifying those with the strongest overall momentum characteristics.
Further Research
