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Quantitative Vs. Qualitative Analysis: Analyzing A Company Is Like Evaluating A Potential Love Interest
Posted by: Jason Fieber (IP Logged)
Date: January 22, 2014 08:09AM
This article is meant to follow up on some of the concepts I laid out in my last post - where I revealed how I analyze and value stocks. What I'm going to discuss today is why I feel it's more important to focus on the qualitative qualities of a company, rather than putting more emphasis on the quantitative fundamentals of a business. Now I'm not saying that looking at fundamentals like growth rates, debt levels and dividend growth isn't important. On the contrary, it's imperative you inspect the numbers and make sure a company stacks up. However, I don't think that's where the analysis stops, and rather maybe just where it begins.
I realized a while ago that when I'm evaluating a company's future prospects I'm really looking at the quality of the business. And by that I'm trying to determine how many competitive advantages a company has which would allow me to gauge how wide the economic moat is.
But looking simply at revenue growth, earnings per share growth or ROE over a certain time period will not really tell you the whole story. While I view all of these metrics as very important, they're all backward-looking. They can only tell you how well a company did over a certain time frame, not necessarily how well itwill do going forward.
And while history tends to repeat itself, and many high quality companies tend to maintain similar growth rates over a long period of time I don't want to overly rely on what has already occurred to reasonably determine what's still yet to come.
What I try to do to get a feeling for how likely it is a company is going to continue to grow at advantageous rates over a long period of time is focus on the qualitative aspects of a company. While this is an extremely nuanced and subjective method, I think it's imperative to shy away from just investigating pure numbers and look at what makes a company great. Why do consumers or other businesses buy their products and/or services? Do they seem to know their market well? Are they innovating? Do they have brand name products that people are willing to pay a premium for? Do they have well-established distribution networks and good relationships with vendors? What's the reputation like? Are there significant barriers to entry to keep competition at bay?
While it's impossible to quantify many of these qualities, this is partly what makes investing fun and interesting, while also probably being one of the reasons you see very successful investors and then not-so-successful investors. Some investors are just better equipped to judge the character of a business, and therefore will be in a better position to reap the rewards.
How I look at this is I like to compare analyzing a company to evaluating a potential love interest.
That may seem funny at first, but think about it for a minute. If you meet someone and you're evaluating them as a potential partner what are you going to focus on the most: their quantitative qualities or the qualitative aspects of their character?
You could simply focus on the quantitative qualities like how much money they make, their net worth, the kind of car they drive, their age, how much debt they carry, their assets, liabilities, how much they've been able to grow their net income, etc. While it's important to make sure you're not dating someone who's completely irresponsible with money as you don't want to ruin your own financial future, it's also likely that this isn't where you end your evaluation. This is likely where you simply screen candidates for future interest. If they're responsible with money and they appear to not be a total deadbeat you'll probably want to get to know them better. This is where focusing on their qualitative aspects, or their character, comes into play.
I don't know about you, but when I'm looking for a potential mate I'm instead going to take a hard look at character traits that are hard to quantify, like: their sense of humor, intelligence, honesty, kindness, ability to get along with my family, optimism, compassion, sincerity, trustworthiness, spontaneity, sense of adventure, etc.
What sense would it make to date someone who has a great balance sheet and income growth if they're a horrible person? And in that same regard, why would you want to invest in a company that's been able to grow the top line and bottom line at a decent clip over the last decade but faces serious questions with the business model because of potential issues like technology changes, consumer habits, increased competition or regulatory demands?
You wouldn't have wanted to invest in Eastman Kodak Company (EKDKQ) at the height of their growth while not taking the threat of digital photography seriously. Similarly, I'm currently strongly looking at Intel Corporation (INTC) as an investment in my own portfolio that may have qualitative issues I didn't take seriously enough when investing in the company three years ago. The trend behind PC growth is troubling and so far Intel has not had a serious answer for mobile computing to make up the difference. ,
The point behind this isn't to be an investor that never picks a dud; it's to try and limit them. Just like the dating world can be frustrating because accurately determining a person's character is difficult at best, becoming great at determining the strength of a company's economic moat is a lifelong exercise and something an investor can continually improve at.
Again, I'm not saying to not take an extremely hard look at the fundamentals of a business. If a company can't manage its balance sheet well, or show a history of being able to grow earnings and dividends enough to be an attractive investment, then you won't even want to investigate the qualitative aspects of the business. However, if it does pass muster then I encourage you to take the qualitative analysis extremely seriously because it will be the competitive advantages that a company has been able to build up over the years that will ensure future economic success for both the business and you as an investor.
Full Disclosure: Long INTC
How about you? Do you focus more on the quantitative qualities of a business or the qualitative aspects?
Thanks for reading.
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Stocks Discussed: INTC,