Quantitative Vs. Qualitative Analysis: Analyzing A Company Is Like Evaluating A Potential Love Interest

Become a better investor

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 it will 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.

Photo Credit: fotographic1980/FreeDigitalPhotos.net

Comments

  1. says

    The qualitative aspect is at least as important as the quantitative. I forget to write about that sometimes but I’ve been trying to cover that more in my stock analysis reports. The quantitative tells you whether the stock price is right but the qualitative tells you whether the company is right. I’ve really like this series on how you analyze companies to invest in.

    • says

      Pursuit,

      Absolutely. The qualitative analysis, while extremely subjective, should never be ignored. Fundamentals are a great place to start because numbers are a hard science, but numbers only tell you what’s already happened.

      Best regards!

  2. says

    Couldn’t agree with you more Jason. Performance and financial metrics only take you so far. It is like traders who focus only on the technical trends or otherwise to trade. By adding an extra emphasis to what makes a company have a defensible moat, develop a new revenue source, or any other item that doesn’t yet reflect in the numbers is so important. In other words, it is part of the reason some folks draw on investment ideas from those companies and items you see and use in every day life.

    • says

      w2r,

      I agree with what you’re saying. To a degree, qualitative analysis is what really separates a long-term investor from a short-term trader. I’m not interested in technical signals or anything like that, I’m interested in knowing how profitable a company will be 10 or 20 years from today.

      Cheers!

  3. Spoonman says

    This post has one of the best titles ever! Qualitative analysis is very important, but very difficult to get right since it can be slippery. I see a company I invest in as a marriage of sorts, the hope is that it will lead to lifelong returns!

    This posts are great, you keep hitting it out of the park!

    • says

      Spoonman,

      Glad you enjoyed the post!

      Yeah, they say don’t marry stocks. Well I’m more than happy to marry a company if it continues to do the right things and increase my pay. Treating me right and paying my bills is a great relationship. :)

      Best wishes.

    • Spoonman says

      Speaking of marriage with stocks, I just parted ways with the rest of my INTC position. It was only around 1% of my portfolio and I had other stocks ready to replace it (TGT, and T. The bulk went to TGT but I though a bit into T to fully fill the income gap left by INTC).

      Maybe some day I will invest in INTC again if it looks like it’s poised to grow the dividend again.

    • says

      Spoonman,

      I think I’m going to have hire your divorce lawyer. I didn’t have time today to do anything about my INTC investment because I was busy at work. Tomorrow is a bit lighter, so I’ll have to mull this over. I think I’ll have to part ways with Intel here. I was going to give it another quarter, but 7 straight quarters of no dividend raise is concerning. I’m a dividend growth investor after all, not a dividend static investor.

      I see some other opportunities here, so I’ll have to think on this overnight. INTC may crack mobile, or may not. But it seems like I’m not being rewarded properly for my patience in the meantime.

      Nice moves on TGT and T. Both look to have better prospects going forward, and earnings growth should be more visible.

      Best regards.

  4. Steve says

    The problem with qualitative is that it is much easier to discount strong qualitative evidence when an investor is emotionally attached to a stock. Just look at those who either love Intel and those that think Intel is finished. Both tend to rely primarily on the qualitative arguments to prove their point. I find that it’s harder to be objective when evaluating the qualitative elements of a stock.

    Steve

    • says

      Steve,

      You’re certainly right. Qualitative analysis, as mentioned, is very subjective. However, that’s not to say you shouldn’t practice and figure out what works for you. And besides, you won’t be right 100% of the time anyway. That’s where diversification and proper weightings come into play.

      Take care.

  5. says

    Great article DM. This article really hits on my fear for retail in addition to tech. Like so many, TGT looks like a potential bargain due to the short term issues around the recent data breach. It has been a great company with strong management so I expect it to come back strong. As a result, I am strongly considering establishing a position in here. That said, there is a small part of me that is concerned about the longer term prospects as the internet (Amazon) continues to take market share. While I think TGT will continue to grow for at least the next 5-10 years, will its growth rate decline significantly over the medium or long term? This concern has me torn between purchasing TGT at a price I view as likely attractive and other securities like GIS or CVX. If TGT falls again tomorrow, may just have to pull the trigger though :-)

    • says

      Divi Me Up,

      While I find retailers like WMT and TGT attractively priced right now, I also would not make them a cornerstone of my portfolio. The winds of retail change every decade or so, and you don’t want to be caught going in the wrong direction. However, if you think about any investment you’ll find reasons not to invest, or things you don’t like. You have to sift through the noise and figure out if the company has real, fundamental problems with the business model or if the issues at hand are transitory in nature. And only you can answer that question for yourself. As always, it’s important to diversify.

      Best wishes!

  6. says

    hey been a while since i’ve posted. i’ve still been lurking though.

    just wanted to point something out in regards to the shift to digital that killed eastman – i think a similar shift is going to happen for healthy food.

    interesting fact, in 1970 no states had more then 10% obesity population, fast forward 40 years to the present day and no state has less then 30% people obese, quite the shift. i personally believe KO and MCD are some of the biggest offenders of this trend. i still think these are fantastically run businesses and will likely continue to do well, however i think the obesity problem is at a bubble – a shifting point of sorts like the digital age was to eastman. i notice between pep, ko, mcd, pm, mo, lo, and i probably missed some you are weighted pretty heavily towards being unhealthy. then i notice you have jnj, mdt, bax and otherstuff towards combating that unhealthiness. then i notice you have nothing like wfm or unfi towards avoiding it all together. unfortunately i know wfm and unfi and other stocks of the sorts aren’t dgi stocks so they are off limits to you. just an interesting thought, the health craze is picking up steam and isn’t going away in my opinion.

    and p.s. coke zero and diet coke are still incredibly bad for you :P

    • says

      also i thought i’d mention – as shrewd as it may sound – im a capitalist at heart and whatever company i feel will return me the most will get my investment, regardless of my personal beliefs. if it is legal by the US standards then it’s good enough to earn my investment. i have a decent amount of my assets in ko, mcd, and pm myself. i’m just saying i feel as if a big shift will be coming in the years. however, that could just be because i live in california and everyone is health conscious, or at least pretends to be! hah

    • says

      Took2Summit,

      What I see when I look at the numbers that KO and MCD post I don’t see this massive exodus away from their products. People may talk about drinking grass shakes, but they’re certainly still eating cheeseburgers and washing it down with Cokes. However, just because you spend money on Coca-Cola products or decide to stop by a Mickey D’s doesn’t mean you’re eating and/or drinking unhealthily. Coke sells a ton of healthy products, and MCD has salads, yogurt and fruit on the menu. If people choose to order a Quarter Pounder that’s not really the fault of McDonald’s.

      By the way, I keep hearing about how fast casual restaurants with healthier options like Chipotle are going to destroy McDonald’s – which is interesting as Chipotle was a MCD divestiture a few years ago. However, according to this site:

      http://www.chipotle.com/en-us/menu/nutrition_calculator/nutrition_calculator.aspx

      A chicken burrito with a side of chips and guac is 1,990 calories. Healthy? Nah.

      However, I’d be more than interested to invest in a company that makes great tasting, healthy food if they’re able to pay a competitive and rising dividend. A trend is one thing, but a company that is able to capitalize on a trend by becoming profitable enough to build up a record of growth so strong they can raise the dividend every single year for years on end is quite another.

      Cheers!

  7. says

    Nice article, numbers are only half the story. I do screen for numbers first as it cuts down on research though.

    INTC: I’m out if it doesn’t increase the next dividend. I have a strong feeling it stays flat. No, it’s not going out of business anytime soon. Yes, it’s not doing what I bought it for. I’ll replace it with something that meets my expectations. Heck a utility with 2% dividend growth is better at this point (for my goals anyway), but maybe Intel will surprise.

    TGT/WMT: I bought a little TGT today, but plan to keep it a small/medium position because I don’t particularly like retailers. If I’m going retailers it has be discount stores that can compete on price and sell products that don’t make sense online. Who would want to buy food (it spoils) or clothes (can’t try it on) on a website? Maybe it’s just me, I think people actually do buy clothes online o.O

    Best wishes my friend!

    • says

      CI,

      I’m also concerned about Intel here. And I think I’m going to wait until the next quarter as well. If the next dividend isn’t raised, and raised enough to be interesting, I’m also out. SYY has been another investment that has been a bit disappointing, but they do continue to raise that dividend just enough.

      I’m concerned about online retailing as well in terms of how it will affect B&M stores like WMT and TGT. However, I’m confident TGT and WMT will increase their own online sales as the online market isn’t a zero-sum game where Amazon wins and everyone else loses. In addition, Amazon’s ascent is more damaging to small town retailers, in my opinion. Generally speaking, local retailers won’t have the supply chain or pricing power to keep up with a behemoth like Amazon, whereas Wal-Mart can compete in the same arena. If anything, online shopping may stamp out the last of the traditional competition for retailers like TGT and WMT. And unless it gets to the point where nobody shops at stores ever again, I think they’ll be fine.

      Thanks for stopping by!

      Best regards.

    • says

      Aspenhawk,

      I also wish I would have chose QCOM over INTC. It has done much better in the mobile arena, and has been a better investment on the whole. I haven’t given up on INTC quite yet, but I’m on the ropes.

      Great tech pick!

      Take care.

  8. says

    I like the metaphor, DM. I think we personal finance inclined folks can get a little too caught up in the numbers — good point about remembering to consider the qualitative, too.

    • says

      DB40,

      Thanks! Glad you enjoyed it. :)

      I agree. Numbers, while extremely important, aren’t the whole story. I love numbers as much as the next guy, but I also want to know a company’s story.

      Best wishes!

  9. says

    DM I have heard enough on the INTC chatter! Intel is a great company. It reprepresents a profitable position that yields a nice dividend in my portfolio, it has not been a drag at all, and all these guys out there like to bash it around. I will stick with Intel, not for the reasons they bash around, because Intel is Intel.

    • says

      Katz,

      I’m not bashing INTC. I’m quite hopeful they turn things around. I hate selling, especially if the future still looks bright. However, as a dividend growth investor I have to make sure my investments are serving their purpose. Not growing the dividend is a sign of trouble, in my view, and INTC raised the red flag last year and they haven’t really built any confidence so far in 2014. I hope they make some serious inroads into mobile very soon or I’ll really have no choice but to invest in something else that has a brighter future and a growing dividend.

      Best regards!

  10. says

    “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?”

    Answering these questions is very difficult.
    I love numbers and math. I love to calculate things and end up getting a 0 or 1 out.
    Or a value that can be compared.

    But in these matters you must appreciate – and if your look in this industry may not be familiar is very easy to completely misjudge!

    I hate uncertainty – and these questions can not be answered unequivocally.

    regards
    D-S

    • says

      D-S,

      You’re correct. Qualitative analysis is very subjective, and impossible to determine as truth.

      However, that’s simply part of investing. When you’re investing in a company you’re really making a bet on the unknown. You can do all the quantitative fundamental analysis you want, and ultimately you’re still making a bet on the future using past numbers. Analyzing past revenue, EPS and dividend growth rates is easy because they have already come to pass. There is no guesswork involved. However, we as investors make money on the future, not the past. And that’s where it gets hard. Furthermore, I think this is where great investors are separated from average investors – the ability to reasonably forecast what’s going to happen is worth huge returns, obviously.

      However, the great thing is that many of us do not need to be fantastic investors to achieve our goals. And beyond that, I really only aim to avoid the big losers rather than aim for home runs. I’d rather be reasonably correct than precisely wrong.

      Cheers!

    • says

      Charles,

      I’m just not feeling the love from Intel right now, and my confidence is dwindling by the day. As a dividend growth investor it’s imperative to my strategy that my investments grow the dividend. It’s right in the title of the strategy. And INTC is not doing so. I may give them another quarter, but after that I’ll have to move on. Maybe they’ll figure out mobile, maybe they won’t. But not growing the dividend doesn’t give me the confidence I need to stay on board and find out.

      Take care.

  11. Anonymous says

    Jason, what are you thoughts on “emerging” dividend growth companies such as Costco, Starbucks, and Nike? These companies don’t have nearly the track record of historical dividend increases as a Walmart or McDonald’s, but sometimes it pays to have some foresight about what companies could rise to behemoth status 20-30 years from now….I am personally eyeing Starbucks right now…while their dividend yield is still a bit low at around 1.4%, they are aggresively raising it 20-25% a year, and there are no signs of that slowing down…Just interested in your thoughts on these companies as dividend growth stocks for someone with a 20+ year horizon…

    • says

      Anonymous,

      I think companies just starting a dividend growth track record make for great investments, assuming they pass a thorough analysis. The only issue with some of these stocks that are transitioning from a growth phase to an income-producer are that they still trade with inflated P/E ratios. I don’t mind paying up for quality, but I do mind paying for growth that may or may not come. SBUX is one that does interest me quite a bit right now, but CSCO also looks good. In the end, I’d just have to see the right price.

      Best wishes.

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