Introduction To Qualitative Analysis: Stock Tips

In this post, we looked at the concept of fundamental analyis, which in a nutshell is a technique that uses the information provided about a company, both qualitative and quantitative, to calculate the value of their shares, and determine whether they are under valued by the market or not. Today, we delve deeper into qualitative analysis.

Qualitative analysis looks at factors about and around the company that aren’t numerical, but affect the valuation of the company. When you’re carrying this out, you need to look at several factors:

1. Business Model: This is a term that has been misused and over used of late, but in simple terms, this is asking yourself, “what does this company do?”. How does it make money? While some business models are easy to understand, for example Safaricom or East African Breweries. However, Centum for example is an investment company that has made investments in various companies some listed in the NSE, and in different industries, you need to understand all this when considering it as an investment target.

It is important to know how a company makes it’s money, and what it defines as making money.Again a useful comparison: Safaricom defines making money as selling airtime, M Pesa revenues etc which are pretty simple, but to Centum, revenue may not necessarily mean cash coming in, it could mean growth in their assets. You need to understand this, and the implication of a company’s business on you as a shareholder.

2. Competitive Advantage: What is the company doing differently from its competitors? This is what makes a business stand out, and ensures long term success of a company. In Good To Great, Jim Collins says that one of the factors that defines a great company is to be able to define THAT thing that the company can be the best in the world at, and doing it. As a prospective shareholder, you need to be able to define what the company is good at, and assess whether it shall be able to sustain the edge in the long term. Remember, in stocks investing, long term could be tomorrow, or 10 years from now.

3. Management: This is often the hardest to assess as an individual investor in a publicly listed company. The financial statements will give you basic professional information about the company’s management,you will never find dirt here (obviously). There are four ways to analyse the quality of a company’s management management: first, networking (the power of grapevine to give you interesting information), second attending AGMs to observe how well they’re answering off the cuff investor questions. Of course, be armed with your own questions.

The third way is ownership. Does management own shares in the company? If the CEO doesn’t, this could be a red flag. Finally, past performance: Google search will give their biographies and CVs,look at their job history and past accomplishments, and how those other companies fared after they left, especially when it comes to CEOs. You don’t want to invest in a company where the CEO runs a solo show, only for it to decline after he leaves.

4. Corporate governance: This is the relationship and roles of the various stakeholders, and ensuring that proper checks and balances are in place to prevent unethical practices. Corporate governance also covers financial information transparency. You should asses the quality and depth of information revealed in a company’s financial statements and notes, especially about its strategy.

The timeliness and quantity of information a company gives to shareholders could be indicative of the viability of the company as an investment. An example I could give here is the Facebook IPO, where the lead advisers withheld key revenue information from the investors, which eventually led to the IPO being a flop. Be wary of such companies, because as a shareholder, you do not have much control over the quantity of information you receive.

5. The Industry: When analysing the industry, be sure to look at the company’s customer base. A company that relies on one key client for a significant portion of it’s revenues should for example be a red flag.

Another factor is the company’s market share, that is the percentage of the total market that it’s able to command vis a vis it’s competitors. When a company is significantly bigger than it’s competitors, it is able to absorb it’s costs better because of higher revenues.

Finally, you need to look at the overall industry growth, that is the growth of the customer base, the likelihood of bigger competitor getting into the market, and the effect that would have on your target client. The final area to look at is regulation, and it’s effect on the company’s profitability. Sometimes changes in the law of the land or tax laws can have an adverse effect on the business, you need to asses this risk.

Let’s keep learning, look out for the next stock tips post!