Quantitative vs. Qualitative Approach to Value Investing?
There is a debate between two approaches among investors: qualitative vs. quantitative. In reality, every investor adopts at least a little of both approaches; but may emphasize one or the other.
The qualitative approach concentrates on the quality of the company. Emphasis is put on the company’s products, services, management, competitors, etc. Special attention is given to finding companies with sustainable competitive advantages .
Qualitative investing requires assumptions about the future that are made on the basis of quality. The analyst will make judgements on the prospects of the stock based on the qualitative attributes of the company.
This approach is associated with Warren Buffet. Buffett is known for buying “wonderful companies” at a fair or reasonable price. Less emphasis is put on diversification versus finding and sticking to quality investments. An investor with an exceptionally long time horizon and the desire to buy and hold for many years might lean towards this approach.
If you bought a better than average company its performance may make up for the fact that you did not pay a bargain price. In other words, if you hold a stock for 20 or 30 years it might not matter that you paid a fair price (versus a bargain price) for a stock. For a long holding period the quality of the company may be more important than the price paid.
Holding a quality company for several decades can easily overcome paying a little too much for a stock. However, unlike Buffett, most investors don’t think in terms of holding a stock for decades. The shorter the holding period the more important the price you pay.
In reality the average holding period for a stock is less than one year. This is most likely one of the reasons studies show the average investor underperforms the market by 3 – 5 percentage points a year.
Short holding periods (I would define as less than 5-7 years) increases the importance of the quantitative approach. It also increases the need for a margin of safety.
A quantitative approach concentrates on the income statements, balance sheets, and cash flows, and analyzes the relationship between price and intrinsic value . Current valuations are compared to historical valuations and other similar companies.
The difference between what you pay and intrinsic value of the stock is the margin of safety. The reason for having a margin of safety is to make accurate forecasts about the future irrelevant. Let’s face it; few of us can accurately predict the future.
The larger the margin of safety the more latitude for negative conditions before you have a loss. At the same time, if expectations are exceeded, your profits will be exponentially higher. Diversification is a key component of quantitative investing.
A quantitative approach places the emphasis on analysis of the stock(s) versus analysis of the company. This approach is associated with Benjamin Graham. I highly recommend Graham’s The Intelligent Investor for those who want a deeper understanding of value investing. Or you can read my review of the book here: The Intelligent Investor Book Review.
The danger in paying too much for a good quality company is, without a margin of safety, your assumptions and forecasts have to be correct. A major problem for investors in selecting dividend stocks is knowing whether the price of the stock already reflects the quality of the company.
Here is a quote from Deep Value:
“Qualitative factors suffer from the same basic problem: It is impossible to determine the extent to which they are already reflected in the price of a given security….. the analyst should be concerned primarily with values that are supported by facts and not with those that depend on expectations.”
In other words, I might find a stock that passes all my 30+ qualitative and quantitative metrics for dividends, balance sheet, income statement, cash flow, profitability, and Piotroski f-score, but fail the valuation metrics by a large margin. That would most likely indicate a quality company that may be priced for perfection (with no, or a negative, margin of safety). This might be a stock I would want on my wish or watch list to buy at lower prices. But, at current prices, it may be a terrible investment solely because the price of the stock is too high.
It’s not what you buy; it’s what you pay for it. A high quality asset can constitute a good or bad buy, and a low quality asset can constitute a good or bad buy…..the failure to distinguish between good assets and good buys, get most investors into trouble.
Howard Marks – The Most Important Thing
For the quantitative analyst this means the valuation metrics are the most important part of stock analysis. That doesn’t mean they are not important to the qualitative analyst, just not as important (they are willing to pay a “fair” price). When you find quality at bargain prices then you have an investment where the odds are heavily in your favor for an above average rate of return.
Quantitative vs. Qualitative
The quantitative vs. qualitative debate is relevant. Investors should use the approach that best fits their holding period and investment style. In reality, all analysts use both quantitative and qualitative approaches. Both approaches have value. Your investment style and holding period might determine which one should be emphasized.
When selecting dividend stocks the ultimate goal is to find quality companies at prices that provide a margin of safety.
If you don’t have the time to do your own research, consider the Dividend Value Builder Newsletter. It will provide the information you need to make informed investment decisions.
Value Investing Portfolio Management Guides
ETF Starter Portfolios - Arbor ETF Conservative Portfolio & Arbor ETF Aggressive Portfolio
Dividend Value Builder - DVB Analyzer Newsletter & DVB Portfolio Newsletter
AAAMP Value Newsletter - Global Deep Value Asset Allocation Portfolio
While Arbor Investment Planner has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. The sole purpose of this analysis is information. Nothing presented herein is, or is intended to constitute investment advice. Consult your financial advisor before making investment decisions.