Twin Momentum is a unique investing approach that combines two powerful momentum factors to identify stocks with strong potential for outperformance. Validea’s Twin Momentum strategy is based on the research paper “Twin Momentum” by Dashan Huang, Huacheng Zhang, Guofu Zhou, and Yingzi Zhu, which explores the effectiveness of combining price momentum and fundamental momentum in stock selection.
The concept of price momentum is well-known in the investment world. It refers to the tendency of stocks that have performed well in the recent past to continue their outperformance in the near future. Fundamental momentum, on the other hand, focuses on the improvement in a company’s underlying fundamentals, such as earnings growth, revenue growth, and profitability.
The Research on Twin Momentum
The “Twin Momentum” paper by Huang et al. demonstrates that combining these two momentum factors can lead to superior investment returns compared to using either factor alone. The authors found that stocks with strong price momentum and robust fundamental momentum outperformed the market consistently over their study period.
The key findings of the paper are as follows:
- Portfolios that combine price momentum and fundamental momentum outperform portfolios based on either factor alone. The “twin momentum” portfolios generate higher returns and exhibit better risk-adjusted performance.
- The outperformance of twin momentum portfolios is consistent across different holding periods and rebalancing frequencies, indicating the robustness of the strategy.
- The twin momentum effect is stronger among smaller stocks and stocks with lower analyst coverage, suggesting that the strategy may be particularly effective in less efficient market segments.
- The authors propose potential explanations for the success of the twin momentum strategy, including the idea that it captures both the short-term and long-term prospects of a stock, as well as the notion that it helps to filter out stocks with temporary price surges that lack fundamental support.
Validea’s Twin Momentum Strategy
Validea’s Twin Momentum strategy incorporates the findings of this research and applies a rigorous set of criteria to identify stocks that exhibit both price and fundamental momentum. The strategy evaluates stocks based on several key factors:
- Earnings: The strategy looks for companies with consistently growing earnings, as it is a key driver of fundamental momentum.
- Return on Equity (ROE): High ROE indicates a company’s ability to generate profits from shareholder investments, which is crucial for fundamental momentum.
- Return on Assets (ROA): ROA measures how efficiently a company uses its assets to generate profits, providing another perspective on fundamental strength.
- Accrual Operating Profitability to Equity: This factor compares a company’s operating profitability to its equity, helping to identify companies with strong profitability relative to their equity base.
- Cash Operating Profitability to Assets: This ratio assesses a company’s cash operating profitability in relation to its total assets, providing insight into the company’s cash generation capability.
- Gross Profit to Assets: This factor evaluates a company’s gross profit margin relative to its total assets, indicating the company’s pricing power and operational efficiency.
- Net Payout Ratio: The net payout ratio considers the company’s dividend payments and share repurchases relative to its earnings, providing insight into the company’s capital allocation decisions.
By combining these criteria, Validea’s Twin Momentum strategy aims to identify stocks that are not only performing well in terms of price but also exhibiting strong fundamental momentum. This dual focus helps to filter out stocks that may be experiencing temporary price surges without underlying fundamental strength. By selecting stocks with both price and fundamental momentum, the strategy seeks to invest in companies with solid business fundamentals and positive market sentiment. This combination can lead to more consistent and reliable returns over time.
The Twin Momentum strategy can also help investors navigate different market conditions. During bull markets, the strategy can identify stocks that are likely to continue their outperformance based on their strong momentum. In more challenging market environments, the focus on fundamental momentum can help identify companies that are better positioned to weather the storm and emerge stronger.
Here are five stocks that currently score 100% according to Validea’s Twin Momentum strategy:
- Broadcom Inc. (AVGO): Broadcom is a global technology leader that designs, develops, and supplies semiconductor and infrastructure software solutions. The company has demonstrated strong earnings and revenue growth, along with expanding profit margins and high ROE.
- Salesforce, Inc. (CRM): Salesforce is a leading provider of customer relationship management (CRM) software and enterprise cloud computing solutions. The company has shown impressive price performance and robust fundamental momentum, driven by strong earnings and revenue growth.
- D.R. Horton, Inc. (DHI): D.R. Horton is one of the largest homebuilders in the United States, constructing a wide range of homes across various price points. The company has demonstrated consistent earnings and revenue growth, high ROE, and strong price momentum.
- Netflix, Inc. (NFLX): Netflix is a leading provider of streaming entertainment services, offering a wide variety of TV shows, movies, and documentaries to subscribers worldwide. The company has demonstrated solid price performance and fundamental strength, driven by its growing subscriber base and expanding profit margins.
- NVIDIA Corporation (NVDA): NVIDIA is a leading designer of graphics processing units (GPUs) for gaming and professional markets. The company has shown robust revenue growth, expanding profit margins, and strong price momentum.
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