For many years now there is a battle of sorts brewing between two forms of analysis in stock picking. The fight is between quantitative versus qualitative forms of investing. Dive deeper and one would find that the fight is between a great teacher’s style of investing and that of his student. Ben Graham, the father of quantitative investing selected his investment ideas by looking only at historic numbers and publicly available information. His research started and ended with annual reports and periodic result updates that the companies disclosed publicly. Graham’s student Warren Buffett pioneered the qualitative style of investing.
Here’s a look at both the style of investing to find which one suits you best.Quantitative Analysis
Quantitative analysis is taking a bet by looking at the rear mirror. Quantitative analysts and investor scan through the financial numbers of the company and also the valuation history of the company over a period of time. They then compare fundamentals of the company with those in the peer group. These investors are least concerned with the name of the company, or the group it belongs to or the sector the company is in. They believe only in valuation and buying the company cheap based on its relative valuation and with enough margin of safety.
Such investors rarely attend analyst meetings or annual general meetings (AGMs) of shareholders or look at news pertaining to the company. They wait for the company to announce its numbers and then evaluate their position accordingly. A quantitative analyst or ‘Quants’ as they are called, believe that all news and events around the company, the sector and the economy is either reflected in the company’s numbers or in its value. They are not bothered by the price of the company, but look at its value.
Ben Graham was of the opinion that talking to management is a futile exercise as their view about their own company would be biased and optimistic. The analyst’s opinion on the company can change if it interacts with the management. A Quant fund manager normally has a much diverse portfolio containing number of stocks. He believes in playing safe by buying a number of companies that are cheap. He is unaware of what the future holds for the company’s products, nor is he concerned. The fund manager is happy even if a few of his investments work, since they would give him super normal returns while at the same time the others would not be losing too much money, even if he is wrong.Qualitative Analysis
Those following the qualitative analysis path do have a look at historic numbers, but they take their decisions based on ground checks. A qualitative analyst not only talks to the management of the company he is interested in, but speaks to all stakeholders. He would speak to the customers, the raw material supplier, the service provider, traders, vendors and the entire trade channel. He would ascertain the performance of the product by visiting stores if it is a consumer product or even test the product by purchasing one, if it is not too costly like a garment.
A qualitative analyst does in-depth study of the products and compares it with competitive products in the market. He keeps a track of monthly sales figures and monitors the changes on a monthly basis. He prepares a sensitivity analysis of its product at various price points and also how the company’s margins might be impacted by a change in raw material prices. A qualitative fund manager generally holds concentrated bets. As the amount of research and follow-up required is so huge, he prefers to have concentrated bets and makes sure that he is right in most of the cases.
As mentioned earlier Ben Graham’s student and legendary investor Warren Buffett is a qualitative fund manager. But it is a known fact that Buffett started off as a quant fund manager, with most of his initial picks being a result of quant analysis. However, his meeting with Charlie Munger, who later became his partner, and his meeting with Phil Fischer changed his opinion on investing. Buffett made it a point to study his investing companies very closely, especially the team that runs the show before taking a bet.Which method is better?
It is difficult to pinpoint one method that would be best in all circumstances. But most fund managers these days follow a mix of both the approaches. Earlier it used to be advisable for a retail investor who would find it difficult to closely follow every company by checking the product’s performance and do a competitive analysis, to use the quantitative approach for investing. This form was favoured as it gave limited down side even if the choice was not right since the investor was buying with enough margin of safety.
But there is a drawback in this approach. The waiting period time is too long. If the market is in a bull run the investor would be sitting out the entire bull-run to wait for frenzy selling to pick his stock. Few fund managers, let alone retail investor have the patience to wait in a roaring bull market.
But these days with analyst reports being freely available and sector information being covered well by media, a combined approach is advisable. There is no harm in knowing the company you want to buy and hold. A quantitative analyst might have found value in pharmaceutical or an information technology stock after they had crashed. He would have probably bought it without knowing that the reason for the fall is a change in the external environment. He might be right someday, but his capital would be locked in the interim.
On the other hand a qualitative analyst would have grasped the changing environment and stayed clear of these stocks. Since the valuations are compelling he would be screening both the industries for signs which would take time to reflect on the profit and loss account or balance sheet of the company. He might not catch the bottom but a good qualitative analyst would be in the major part of the bull run.(The writer is Executive Director of Trade Smart Online.)