03) Stock Picking Strategies: Qualitative Analysis

When we talk of determining a company’s value, there is more to it than just profit, cash flows and the numbers.  Fundamental analysis is a wide area that covers not a company’s intrinsic value but subjective factors as well.  We will now cover the basics of qualitative analysis to pick stocks.

Management

The core of every business is people, in this case: management.   These are the people who make or break decisions for the company.  To see whether or not a company has a strong management team or not, one only needs to look at the five W’s:  who, where, what, when and why.

Research plays an important role in picking good companies to invest in.  Find out who the CEO, CFO. COO and CIO are.  These people are the big decision makers in the company.  Where did they come from?  Do they have good education and employment background?  Are they qualified to run the company?  Do they have the necessary know how in order to keep the company in good standing?  Are they capable of the job?

Once you know these then find out what their management philosophies are.  Ask yourself what style of management they follow.  Some people like transparency in business dealings, other prefer the “old school style” and others like to be eclectic in their management style.  Then ask yourself if you like their style of management, if you believe that this style will work for the good of the company and if you agree with this philosophy.

After you’ve gotten to know them a bit, find out when these people took over the company.  A long tenure could mean that the stockholders and its board of directors like the way this team has handled a company thus far.  However, tenure is not all there is to it.  A new team does not always mean that the company is in dire straits.  In the case of Chrysler, Lee Iacocca was brought in as CEO during the brink of the company’s bankruptcy to renew and rejuvenate Chrysler’s status as a major player in the Auto Industry.

Lastly, ask yourself why these people have become managers.  Do they have the qualities you look for in a good leader?  Was he hired because of past achievements or because of familial ties?

How Does the Company Make Money?

To further analyze a company’s qualitative factors, know its products and services.  In MBA speak it would be “What is the company’s business model”?  However, most people would simply ask “how does it make money”?

Knowing what a company does to generate revenue is an important factor in deciding whether or not it is a good stock to buy.   People will sometimes brag about the profitability of a business without even understanding why a company is profitable, or what it sells in the first place.  Take for example the dotcom fallout during the late 90’s.  A lot of people were buying stock without even understanding what these companies sell or do.  This is called herd mentality.  People simply bought stock because of the meteoric rise of dotcom companies and the expected growth potential which in turn led to a market crash.

The Competition

Aside from looking into the company itself, take a look at the characteristics of the industry.  Is there room to grow in that industry?  A so-so company can reap great rewards in a great industry compared to a so-so company in a bad industry.  Determine the demand for that industry is growing or declining.

Market share also plays a big role in good investment.  Take for example Microsoft.  They are the Goliath of the operating system industry.  In the stock market world, David would have a hard time taking Goliath down as Microsoft can take advantage of the economies of scale.

Generally speaking, the harder it is to enter the industry, the better it is for the investor.  Look at it this way: opening a restaurant entails small capital and minimal skill, which is why we have a lot of restaurants all over the world.  Compare that to opening a pharmaceutical company or an automobile factory, you would need government clearances, highly skilled management and work force, huge capital expenditures, etc.   The harder it is to compete in the industry, the better it is for existing businesses.

The Brand

A good brand name reflects on years of good marketing, sound management and years of product development.  Take for example Coca-Cola. It is the world’s most recognized brand.  Analysts estimate the brand name alone to be worth in the billions of dollars!   For companies like Procter & Gamble, it pays to have dependable brand names like Tide, Pampers and Head and Shoulders because having a diversity of brands minimizes the risk to your portfolio since the good performing brands would compensate for the under performers.

However, it would be wise to stay away from brands that revolve around one person.  A case in point would be Martha Stewart Omnimedia.  Stewart’s legal problems hindered the company’s share performance which had nothing to do with company operations.

Don’t Over-Complicate

You don’t need degrees in Finance to be able to pick out the next hot stock in the Stock Market.   During the 1970’s Hanes marketed L’eggs a brand of pantyhose packaged inside colorful little eggs.  They were placed next to the candy bars, soda and gum near the check out counter since R&D discovered that women frequented the grocery aisles 12 more times compared to where pantyhose is normally displayed.  Their marketing paid off and L’eggs became the second highest selling consumer product during the 70’s.

In his book “One Up on Wall Street” by Peter Lynch, he discussed the time his wife drew his attention to this test marketing by Hanes.  Most women could easily see the convenience of this product and one of them was Lynch’s wife.  Thanks to Mrs. Lynch and a little more research, he was able to turn his investment in Hanes as a solid earner for Fidelity, while some of the Wall Street big boys missed out on the profits.

The point is, not all Wall Street traders have all the info on all the most profitable stocks in the market.  The Average Joe can also make it big on Wall Street.  Sometimes, you just need to dig a little deeper and do more research and who knows, you might bump into the next Hanes.

Conclusion

A company is more than its numbers and figures.   You also need to look at other factors that affect a company’s performance in order to figure out its qualitative value.  In order to make a sound investment, looking at the sales and earnings as well as looking beyond the figures is probably one of the most effective methods of evaluating a potential investment.