It’s Not You, It’s Your Fundamentals

This paper examines whether improvements in company fundamentals – measured through earnings acceleration, earnings surprises, and analyst estimate revisions – predict future equity returns and provide information beyond traditional price momentum. Across US and non-US large- and small-cap universes, business momentum demonstrates broad predictive power. The findings indicate that business and price momentum are related but distinct, and that combining them can produce higher excess returns and information ratios than price momentum alone, though the optimal mix varies by market.

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Introduction

Traditional momentum investing has long been one of the most persistent sources of excess return in global equity markets. By systematically buying stocks that have outperformed over the prior year, investors have historically benefited from the persistence of trend and perhaps the market’s tendency to underreact to new information.

But stock prices are only one manifestation of momentum. Businesses themselves can experience momentum. Earnings accelerate, analysts revise forecasts upward, profitability improves, and companies repeatedly exceed expectations. If markets are slow to fully incorporate these fundamental developments, then improvements in business fundamentals should also predict future returns.

This naturally raises three questions:

• Do improving business fundamentals predict future stock returns?
• Are these signals simply another way of measuring price momentum?
• Or do business momentum and price momentum capture different information that can be combined to build better portfolios?

In this paper, we examine several measures of business momentum—including analyst estimate revisions, earnings surprises, and multi-factor measures of improving fundamentals—across US and non-US equity markets. We find that business momentum is a robust predictor of future returns, that it can provide information beyond traditional price momentum, and that combining the two can create stronger portfolios.

Measuring Business Momentum

Academic research has identified several mechanisms through which improving business fundamentals predict future stock returns. While the methodologies differ, they generally fall into three broad categories: earnings acceleration/business improvement, earnings surprises, and analyst estimate revisions. Together, these measures attempt to identify improving businesses before those improvements are fully reflected in stock prices.

Despite broad agreement that business fundamentals matter, an important debate remains unresolved: Does business momentum simply explain the traditional price momentum premium, or do price momentum and business momentum capture different sources of information? The existing literature offers compelling evidence on both sides of this question, providing the motivation for our analysis.

Our Contribution

This paper builds upon these complementary strands of research by evaluating representative measures of earnings acceleration/business improvement, earnings surprises, and analyst estimate revisions within a unified framework. We compare their predictive ability across US and non-US equity markets, examine whether business momentum subsumes traditional price momentum (and vice versa), and test whether combining both sources of information produces superior portfolio outcomes.

In doing so, we revisit the debate between Chan, Jegadeesh, and Lakonishok (1996) and Novy-Marx (2015) using a broader set of business momentum measures than either study considered. Rather than asking whether any single measure explains momentum, we ask a more practical question for investors: Which measures of business momentum provide the greatest incremental value to a traditional momentum strategy?

These studies provide several plausible ways to measure business momentum. In this analysis, we evaluate representative signals from each category within a common empirical framework.

Conclusion

Momentum is commonly understood as a characteristic of stock prices, but the evidence in this paper demonstrates that momentum also exists within the underlying business. Improvements in profitability, positive earnings surprises, and upward revisions to analyst expectations have historically predicted future stock returns across US and non-US equity markets. The consistency of these results suggests that business momentum is a broad and persistent source of return predictability rather than a market-specific anomaly.

Our results also indicate that business momentum should not be treated as a single, uniform signal. The measures examined capture different stages of the fundamental information process and vary meaningfully in their predictive strength and relationship with traditional price momentum. Analyst estimate revisions are generally the strongest and most consistent standalone signals, particularly in smaller-cap and non-US markets, while earnings acceleration and announcement-based measures provide additional, but more market-dependent, information.

The relationship between business momentum and price momentum is similarly nuanced. The sequential-sort results do not support the conclusion that one universally subsumes the other. Instead, each frequently retains predictive information after controlling for the other, although the degree of incremental value depends on the signal and investment universe. This helps reconcile the competing conclusions in academic literature: business momentum and price momentum are neither completely independent nor interchangeable. They are related expressions of the market’s gradual incorporation of new information.

The composite results translate that insight into portfolio construction. Combining related business momentum measures can produce a more complete and robust representation of improving fundamentals. Combining business momentum with price momentum can also improve outcomes, particularly when the underlying signals possess both strong standalone predictive power and differentiated return patterns. However, the results do not support a mechanical, one-size-fits-all combination. The optimal mix varies across markets, reflecting differences in signal efficacy, overlap, and excess return correlation.

The practical conclusion is straightforward: Business momentum does not replace price momentum; it can inform and strengthen it. By evaluating both what the stock price is doing and what is changing within the business, investors can develop a more complete view of momentum and potentially build stronger, more adaptable portfolios.