Quantitative Data vs. Qualitative Factors
In the comments section of Getting Intimate with Stocks a reader, Mark, asked the following question,
“How much impact does your qualitative data have on your overall perception of a company? Is this a sliding scale depending on the size and scope of the company? I.e. if it is a large multi-national corp. a site visit may not be as reliable as a visit to a small company with a handful of plants.”
Quite simply qualitative data has a huge impact on my perception of a company as a prospective investment. Even when consulting I advocate continuously that investors concentrate on qualitative factors more than quantitative initially.
There is a very simple reason why I spend so much time analyzing qualitative factors of businesses and why I consistently publish about qualitative factors on this website. If a company wants to enjoy quantitative success they have to have solid qualitative fundamentals and business practices. The two concepts are inherently linked and good quantitative numbers depend on good qualitative practices.
Many companies are successful over a short period of time because they simply receive more revenue than expenses and generate profits on that basis. Over the long-term though a company has to have vital components to its operations, strategic management and business model in order to sustain success. There are numerous companies that couldn’t manage their success because of the lack of qualitative fundamentals necessary for their success and usually investors never pay attention to those lessons. We are programmed to look for positive returns; but the contrarian value investor looks to learn from failures with the intention of applying those lessons to his/her future investing approach.
Far too often investors concentrate on financial performance and other quantitative numbers without ever considering what important factors produced those numbers. My clients routinely will hear the following line from me,
“Without strong qualitative performance no company can enjoy sustainable quantitative success.”
Increasing profitability, cashflow, margins, dividends and return on equity could never happen without a company having sound business practices that led to expanding global growth, the development of competitive advantages and a sustainable business.
To put this all in very simple terms:
“Quantitative Data is the past, Qualitative Factors are the future.”
Qualitative data has a huge impact on my overall perception of a company because despite any strong financial numbers in the past I’m buying a company today for the future. Without strong sustainable qualitative business practices the financial numbers (quantitative data) in the future won’t matter because the company will no longer be in business. If they are they will either be experiencing a very difficult business environment in their operations or be on the brink of bankruptcy.
General Electric (GE) is an excellent example of this if you conducted an analysis based solely on historical quantitative data. The company’s historical growth (EPS, dividends, shareholder return) had been stellar prior to the past five years. But the business practices of the company in its financial services business had a huge shift in the qualitative fundamentals of the company and currently explains why they’re in the mess they find themselves in. Had I, or other investors, realized these important changes before the market took notice or the financial arm of the company encountered serious problems investors would have saved themselves a lot of pain and money.
Whenever I lose money on an investment I am driven to determine what went wrong and why. I know that I make mistakes, but by learning from my mistakes I hopefully improve my investing process and examining qualitative fundamentals has made a huge difference in my ability to generate positive returns as an investor and business owner.
It really comes down to risk; despite strong financial performance in the past do I want to own a company with weak fundamentals moving forward? The risk, in my perspective, is too great regardless of what they did in the past. In my recent analysis of Pfizer I alluded to this point very clearly to readers when I sold the stock after Pfizer (PFE) acknowledged they intended to purchase Wyeth (WYE).
In the case of the brewing company I toured in Toronto last year they have numerous plants all over North America and touring one of them might have been an anomaly or provided an unnecessarily biased perspective on the problems plaguing the company in one plant. But when I took the qualitative observations I made about concerns with costs and compared them to the corporate financials to look for a trend I immediately saw what I didn’t want to see from a business practices perspective. Margins were falling and well below their industry peers since a merger had occurred. Inappropriate cost cutting was hurting the company because management wasn’t able to engage employees to increase productivity and efficiencies. The company wasn’t operating as a cohesive unit and management was too focused on cutting costs fixed at the expense of the increasing costs of operations and loss of productivity.
In conclusion an investor needs to remember that qualitative factors will in turn drive quantitative success when they are executed effectively. Without the first you can’t easily manage the second and sustainable profitable businesses are what an investor wants to concentrate on for providing positive long-term returns. My Value Rules that I discuss on this site extensively are all qualitative fundamentals that I’ve learnt about from studying companies for investment or business purpose. Focus on fundamentals first before you look at financial performance and you’ll be surprised how quickly you can determine what companies have Enduring Value.
Thanks Brad, was expecting a short response but I’ll take a full post! Makes sense, qualitative = functioning core of the business.