Qualitative and quantitative investment

Qualitative and quantitative

Buffett’s view

In Buffett’s letter to shareholders in 1967, he described qualitative and quantitative investment methods as follows:

The evaluation of securities and businesses for investment purposes has always involved a mixture of qualitative and quantitative factors. At the one extreme, the analyst exclusively oriented to qualitative factors would say. “Buy the right company (with the right prospects, inherent industry conditions, management, etc.) and the price will take care of itself.” On the other hand, the quantitative spokesman would say, “Buy at the right price and the company (and stock) will take care of itself.”

As is so often the pleasant result in the securities world, money can be made with either approach. And, of course, any analyst combines the two to some extent – his classification in either school would depend on the relative weight he assigns to the various factors and not to his consideration of one group of factors to the exclusion of the other group.

Interestingly enough, although I consider myself to be primarily in the quantitative school (and as I write this no one has come back from recess – I may be the only one left in the class), the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a “high-probability insight”. This is what causes the cash register to really sing.

However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side – the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.

Quantitative targets is getting fewer

In Buffett’s letter to shareholders in 1967, he continued:

Such statistical bargains have tended to disappear over the years. This may be due to the constant combing and recombing of investments that has occurred during the past twenty years, without an economic convulsion such as that of the ‘30s to create a negative bias toward equities and spawn hundreds of new bargain securities. It may be due to the new growing social acceptance, and therefore usage (or maybe it’s vice versa – I’ll let the behaviorists figure it out) of takeover bids which have a natural tendency to focus on bargain issues.

It may be due to the exploding ranks of security analysts bringing forth an intensified scrutiny of issues far beyond what existed some years ago. Whatever the cause, the result has been the virtual disappearance of the bargain issue as determined quantitatively – and thereby of our bread and butter. There still may be a few from time to time. There will also be the occasional security where I am really competent to make an important qualitative judgment. This will offer our best chance for large profits. Such instances will. however, be rare. Much of our good performance during the past three years has been due to a single idea of this sort.

However, the suitable targets that can be found by quantitative investment methods will recover as the market recovers. In the era of non-bear markets, there are only a handful of targets that can be found. Moreover, with the advancement of technology and the popularization of information, as long as the market has wrongly priced stocks, they will usually be found out quickly, and the wrong pricing will be corrected immediately.

In Buffett’s letter to shareholders in 1967, he also directly points out the trend:

However, it seems to me that: opportunities for investment that are open to the analyst who stresses quantitative factors have virtually disappeared, after rather steadily drying up over the past twenty years.

After writing this passage, Buffett said that he would dissolve his earliest investment partnership.

A Few Examples of Quantitative Investing

The Great Crash of 1929

I mentioned in my previous blog article “The past and present of value investing“: In Graham’s era, investors can use his value-based investment method to find many worthy investment targets. In his time, there were about 600 stocks on the New York Stock Exchange (now there are more than 4,000 listed companies in the U.S. stock market). During the Great Crash in 1929, about 1/3 of the stocks whose stock prices were lower than the net value of the company could be found, and there were even 50 stocks. The stock price is lower than the cash on the books of the company.

But if you stick to Graham’s most original value-based investment method (only relying on numbers or P/B value), it is very difficult to find suitable stocks (only a few at the bottom of the market crash that is rare in ten years) Opportunities, and such opportunities are becoming less and less in US stocks; there are many reasons for this, which will not be detailed here). Times are evolving, so must investment methods! This is also the greatness of Buffett.

The 2020 Crash Offers a Buying Opportunity

In Section 5-1 of my book “The Rules of Super Growth Stocks Investing“, on page 354, in the discussion of “When the stock market encounters systemic risks, you can refer to the ratio of stock price to net value”: When the stock market is in bull market, it is rare to see a situation where the price-to-book value ratio is less than 1, but it will definitely appear when the stock market crashes across the board.

When the COVID-19 pandemic hit the global stock market in 2020, on February 25 of that year, there were 499 listed companies whose share price-to-book value ratio fell below 1 times (Taiwan stock market at the end of 2019, there were 1,712 listed companies), including many well-known large enterprises, such as ASUS (Taiex code: 2357), Hon Hai (aka Foxconn, Taiex code: 2317, ticker: HNHPF), Ruentex (Taiex code: 2915), Hon Hai Precision (Taiex code: 2317) and so on.

Japanese stocks are undervalued

In my previous blog article “The commonalities of Buffett portfolio – cheap, fixed income, repurchase“, it is mentioned: Buffett’s 2020 Berkshire purchases of Itochu Corporation, Marubeni, Mitsui & Co., Sumitomo Corporation and Mitsubishi each 5 % of shares. It is worth noting that their share price-to-book value ratio is only 1.2 for Itochu Corporation, and the other four companies are all lower than 1.0; this is really cheap compared with US stocks. Before Buffett bought the five major Japanese trading companies, he should have done a lot of homework. I think the reason is that US stocks are too expensive.

Investment success depends on qualitative analysis

The secret is qualitative analysis

Todd Combs, Berkshire’s new generation of investment manager, believes that it is actually very easy to conduct value evaluation through quantitative analysis, but it is just some mathematics; but the real secret of investment success is qualitative analysis.

95%-99% time is on qualitative

“When Buffett and I discussed stocks, 95% and sometimes even 99% of the time were qualitative discussions, such as where the company’s moat is and where the barriers to entry are, which are basically things that cannot be found in the annual report. “

From the inside out, look at the details first

In the investment process, the correct method is “inside out”, that is, to look at the details first, and let these details slowly converge into the basis, and then you can analyze on this basis, and finally obtain qualitative results understanding.

“Unfortunately, most people start from the outside in. They all start with a narrative, a story, and most of these stories come from hearsay, media reports, research reports, etc.,” Combs said.

He argues that if you start your research with a story, all your opinions will be based on a partial, incomplete story that may itself be wrong.

Fact-based

The same is true for scientific research. You should not start with a story and verify the story. You should start with the facts, and all analysis must be based on these facts.

During the investment process, Combs said that he does not look at the market value of the company. His method is to play a game with himself, that is, to look at a company, do research, build his own model, and come up with a value for the company. Value, and then he looked at the market value. In most cases, the result he got was about 20% of the market value of a company at that time.

Case study: MasterCard

Of course, Combs also shared a surprise moment: when Mastercard (ticker: MA) was listed, its market value was 3 billion to 3.5 billion US dollars, and Combs estimated that it was around 30 billion US dollars at the time, and this is the most worthwhile position In the current situation, the current market value of MasterCard has exceeded 360 billion U.S. dollars, making it the 21st largest company in the world by market value.

Avoid preconceptions

For this research method, Combs believes that its greatest value is that it can avoid the “anchoring effect (Anchoring Effect)”, because when you first look at the market value of a company, you are also anchored by this number. When you get stuck, you will start to question yourself, “Everyone else says this company XXX”, “Why do I think this company XXX”?

Looking for the greatest possibility

In the end, Combs said, when looking at companies, “I want to know what underlying risks they are risking. I look for asymmetric risks and asymmetric benefits that are not being accounted for.”

Qualitative and quantitative
credit: oxfordlingua.co.uk

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