Qualitative Analysis


DEFINITION of 'Qualitative Analysis'

Qualitative analysis is securities analysis that uses subjective judgment based on unquantifiable information, such as management expertise, industry cycles, strength of research and development, and labor relations. Qualitative analysis contrasts with quantitative analysis, which focuses on numbers that can be found on reports such as balance sheets. The two techniques, however, will often be used together in order to examine a company's operations and evaluate its potential as an investment opportunity. 


Loading the player...

BREAKING DOWN 'Qualitative Analysis'

The distinction between qualitative and quantitative approaches is similar to the distinction between human and artificial intelligence. Quantitative analysis uses exact inputs such as profit margins, debt ratios, earnings multiples and the like. These can be plugged into a computerized model to yield an exact result, such as the fair value of a stock or a forecast for earnings growth. Of course, for the time being, a human has to write the program that crunches these numbers, and that involves a fair bit of subjective judgment. Once they are programmed, though, computers can perform quantitative analysis in fractions of a second, while it might take even the most gifted and highly-trained humans minutes or hours.

Qualitative analysis, on the other hand, deals with intangible, inexact concerns that belong to the social and experiential realm rather than the mathematical one. This approach depends on the kind of intelligence that machines (currently) lack, since things like positive associations with a brand, management trustworthiness, customer satisfaction, competitive advantage and cultural shifts are difficult, arguably impossible, to capture with numerical inputs. 

Elements of Qualitative Analysis

Qualitative analysis can sound almost like "listening to your gut," and indeed many qualitative analysts would argue that gut feelings have their place in the process. That does not mean, however, that it is not a rigorous approach. Indeed, it can consume much more time and energy than quantitative analysis.

People are central to qualitative analysis. An investor might start by getting to know a company's management, including their educational and professional backgrounds. One of the most important factors is their experience in the industry. More abstractly, do they have a record of hard work and prudent decision-making, or are they better at knowing – or being related to – the right people? Their reputations are also key: are they respected by their colleagues and peers? Their relationships with business partners are also worth exploring, since these can have a direct impact on operations. 

Perhaps more important is the way employees view the company and its management. Are they satisfied and motivated, or do they resent their bosses? The rate of employee turnover can indicate employees' loyalty or lack thereof. What is the workplace culture like? Overly hierarchical offices promote intrigue and competition and sap productive energy; a sleepy, unmotivated environment can mean employees are mainly concerned with punching the clock. The ideal is a vibrant, creative culture that attracts top talent.

Admittedly, answers to these questions can be difficult to come by. Fortune 500 CEOs are not known for sitting down with small-time investors for a chat or showing them around the corporate headquarters. In part, Warren Buffet is able to use qualitative analysis so effectively because people are so willing to give him access to their time and information. The rest of us have to sift through news reports and companies' filings to get a sense of managers' records, strategies and philosophies. The management discussion and analysis section of a company's 10-K filing and quarterly earnings conference calls provide a window into strategies and communication styles. Clear, transparent communication and coherent strategies are good. Buzzwords, evasiveness and short-termism, not so much.

Qualitative Analysis in Context

Customers are the only group more crucial to a company's success than management and employees, since they are the source of its revenue. Ironically, if a company places customers' interests before shareholders, it may be a better long-term investment. If feasible, it's a good idea to try being a customer. Say you're considering investing in an airline that has reined in costs, beat earnings estimates in three consecutive quarters and plans to buy back shares. When you try to actually use the airline, however, you find the website bug-ridden, the customer service reps cranky, the extra fees petty and your fellow passengers resentful. Now the financials appear to tell a less attractive story: a jaded incumbent squeezes more from its customers while giving less in return, throwing sops to investors until a better firm comes along to sweep them away. 

A company's business model and competitive advantage are a key component of qualitative analysis. What gives the firm an enduring leg up over its rivals? Has it invented a new technology that competitors will find hard to replicate, or that has intellectual property protection? Does it have a unique approach to solving a problem for its customers? Is its brand globally recognized—in a good way? Does its product have cultural resonance or an element of nostalgia? Will there still be a market for it in twenty years? If you can plausibly imagine another company stepping in and doing what this one does just a little bit better, then the barrier to entry may be too low. If the company is not yet established, why will it be the one to create or disrupt its chosen market, and why won't it then be replaced in turn?

The idea behind quantitative analysis is to measure things; the idea behind qualitative analysis is to understand them. The latter requires a holistic view and a fact-based overarching narrative. Context is key. For example, a CEO who dropped out of college would be a red flag in some cases, but Mark Zuckerburg and Steve Jobs are exceptions. Silicon Valley is, for better or worse, a different beast. A look at McDonald's Corp's (MCD) financials a few years ago would have told you nothing about a looming backlash against, cheap, nutritionless food. On the other hand, a purely qualitative approach is vulnerable to distortion by blindspots, over-narrativizing and personal biases. Quantitative measures can act as a check on these tendencies.

  1. Soft Metrics

    A slang term for intangible indicators used to value a startup ...
  2. Quantitative Analysis

    A business or financial analysis technique that seeks to understand ...
  3. Fundamental Analysis

    A method of evaluating a security that entails attempting to ...
  4. Valuation

    The process of determining the current worth of an asset or company. ...
  5. Contagion

    The spread of market changes or disturbances from one region ...
  6. Rule Of 72

    A shortcut to estimate the number of years required to double ...
Related Articles
  1. Fundamental Analysis

    Understanding Qualitative Analysis

    Qualitative analysis is a general term describing the non-mathematical scrutiny used by investors and managers to make investment and business decisions.
  2. Entrepreneurship

    7 Steps To A Successful Investment Journey

    Before you start investing, educate yourself on financial ideas and develop a strategy that agrees with your personality.
  3. Active Trading

    Competitive Advantage Counts

    What's the best indicator of a company's future success? Its ability to succeed when others fail.
  4. Economics

    Portfolio Mismanagement: 7 Common Stock Errors

    Don't lose your shirt over these seven simple - and preventable - investment follies.
  5. Active Trading

    Qualitative Analysis: What Makes A Company Great?

    To understand the qualities that make for a great company, investors must dig deep into "soft" metrics.
  6. Active Trading Fundamentals

    Let Your Intuition Guide Your Investments

    Don't ignore that gut feeling - it might just be leading you in the right direction.
  7. Active Trading

    Economic Moats: A Successful Company's Best Defense

    Find out why some companies thrive while others flounder.
  8. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  9. Professionals

    The Best Financial Modeling Courses for Investment Bankers

    Obtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
  10. Investing

    Where the Price is Right for Dividends

    There are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
  1. How do I take qualitative factors into consideration when using fundamental analysis?

    Fundamental analysis is the method of analyzing companies based on factors that affect their intrinsic value. There are two ... Read Full Answer >>
  2. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  3. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  4. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  5. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  6. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center