Quantitative vs. Qualitative Investing

Quantitative vs. Qualitative Investing

When an investor is deciding whether or not to purchase stock in a company, he or she should perform a qualitative and quantitative analysis.

Qualitative Analysis

A qualitative analysis is basically the non-numbers analysis.  This consists of an evaluation of a company’s brand, mass marketability, competitive advantage, leadership, growth potential, etc.

Qualitative investors care more about the long-term growth potential of a company rather than short-term price fluctuations.  Companies that are currently attractive to qualitative investors, but not to quantitative investors would include Google, Chipotle, Amazon, and Netflix.  When Google, Chipotle, and Amazon had their initial public offerings (IPO’s), quantitative investors claimed that the companies were overvalued.  In contrast, qualitative investors claimed that the future for these companies what limitless.  In a way, both investors were correct.

The qualitative investors were correct because Google, Chipotle, and Amazon ended up being incredibly successful.  An investment in these companies at the time of their IPO’s would now be worth a fortune [this is not true for Google...it's worth 2-3 times its IPO, not "a fortune".  I would say: An large investment in Chipotle and Amazon at the time of their IPO’s would now be worth a fortune, while such an investment in Google would have more than doubled. 

In the quantitative section below, I will explain why the quantitative investors were also correct.

Quantitative

A quantitative analysis is an analysis "by the numbers".  This entails pouring through a company’s financial statements to create a fair trade value.  In other words, quantitative investors look at the current financials of a company to place a price tag on it, and ask if the stock price is significantly above that price tag.  Ratios that quantitative investors put a great emphasis on include the price to earnings ratio, price to book ratio, and PEG ratio (PE ratio divided by the growth rate).

So why wouldn’t a quantitative investor have invested in Google, Chipotle, or Amazon’s IPO?  The answer is that all of these companies appeared grossly overvalued at the time of their IPO.  All of the ratios mentioned above that are important to quantitative investors were astronomically large at the time of their IPO.  For example, when Amazon had its IPO in 1997, the company’s market value was $438 million.  However, the company appeared overvalued because it had not yet even made a profit.  So, if Amazon even earned $1 million, the P/E ratio would have been astronomically high at 438.  Quantitative investors would have a heart attack at the sight of a P/E ratio that high, and probably would have shorted the stock, figuring it was doomed to fail.

The quantitative investor would have been correct in not buying Amazon, because it was not necessarily a good short term investment.  Like many great success stories, there were times when Amazon’s share price was plummeting and short term investors sold their Amazon stock and unfortunately never reaped the subsequent astronomical returns.  Amazon is now worth over $84 billion dollars representing a return on investment of 191,680% from its IPO.  Pretty good!

LinkedIn, Vera Bradley, MAKO Surgical, Green Mountain Coffee Roasters

All of these recommendations are qualitative investments.  It is to be expected that price fluctuations will be great.  We have already seen investments such as MAKO Surgical and Green Mountain increase tremendously in value, however, we have also seen investments like Vera Bradley and LinkedIn decrease in value.  The trick is to "weather the storm" and hold on for the long term if you believe, as I do, that these companies have great products and great leadership that will ultimately dominate their respective markets.  You don’t want to be like the quantitative investor who sold his/her stock in Amazon because the price went down in the short term.  You want to be the qualitative investor who held onto his/her investment and through thick and thin, only to finish financially far, far ahead of the crowd.