Quality Over Quantity

Ian Cassel Blog, Educational 8 Comments

Our personality and experiences shape our investment philosophy. Similar to an artist molding a clump of clay into something desirable, investors mold and shape their investment philosophies over time into something more lasting and profitable. Since your investment philosophy is the cumulative effect of your past experiences, it also forms a focal point or lens on different investing topics. Market participant’s love to debate topics such as: Investing versus Swing Trading, Growth versus Value, Diversification versus Concentration, and finally Qualitative versus Quantitative Analysis.

Great descriptions of Quantitative Analysis and Qualitative Analysis can be found on @BaseHitInvestor’s blog [HERE]. Imitation is the best form of flattery, so I’ve asked for John’s permission to copy/paste his descriptions of the two schools of thought below:

Quantitative Analysis:

  • Analyzing income statements, balance sheets, cash flows
  • Comparing current valuations with historical valuations
  • Comparing valuations and company financials with other companies in the same industry
  • Rarely talk to company management
  • Studies the stock, but not the company (not overly concerned with the company’s products or services)
  • Doesn’t rely on anything other than publicly available data
  • Doesn’t put much weight on the industry or sector, nor the trends of those sectors
  • Doesn’t rely on macro economic trends or overall top down analysis
  • Usually run diversified portfolios since they don’t analyze each company in depth

Qualitative Analysis:

  • Talking to management
  • Relies on “scuttlebutt”: i.e. talking with a company’s competitors, vendors and distributors to gain legal information that others might not have
  • Analyzing in depth the company’s products or services
  • Determining the capability of the company’s management
  • Determining the competitive advantages a company has or doesn’t have
  • Making judgments on the prospects for the industry or general line of business the company is in (sustainable, growing, etc…)
  • Often concentrates the portfolio in a select few positions that have been thoroughly researched

You won’t find anyone that ever says Quantitative Analysis is useless, so the real debate has always been the importance of Qualitative Analysis. I would like to give my perspective, but keep in mind I’m looking at it through the lens of a quality focused microcap investor. I make my living exclusively investing in small public companies less than $100 million market cap. My #1 priority isn’t finding cheap companies, it’s finding great companies early.

Quantitative analysis is very important and it’s what brings to light most new opportunities. It is an important first step which I like to call surface due diligence. To really understand a company you need to look below the surface. Refusing to conduct qualitative analysis is like driving a car without being able to hear. You can still drive. You might even be able to drive pretty well, but most would agree the ability to hear would make you more comfortable and decisive behind the wheel. In the same way you must use all five senses when you conduct analysis into a company.

I hate to break it to you, but there is no such thing as an even playing field. Those investors that work the hardest and make the best decisions win. Period. The more informed you are the better decisions you will make. Going the extra mile to uncover exclusive public information is always a benefit. If I attend a conference where a company presents to a group of investors and the presentation is also broadcast live on the internet. Because I was sitting in the room I could pick up on body language. I could see the CFO roll his eyes when the CEO talked enthusiastically about an upcoming product. I also heard two questions/answers that didn’t make it on the internet broadcast. That is an edge and it’s why going the extra mile to meet management in person is always an advantage.

When Warren Buffett was just getting started and making his first $100,000, he was more of a quantitative analysis Ben Graham disciple. Even back then in 1950 he decided to do qualitative analysis and visited with GEICO’s Lorimer Davidson for hours before investing a bulk of his capital into the company.

“To achieve superior results, you have to have an edge in either information or analysis, or both.”
Howard Marks
In my experience the smaller the company the more you should focus on management and qualitative analysis. Microcap companies become microcaps two different ways. Either they were larger companies that became small (fallen angels), or they were always small. I tend to focus on the latter. This subset of microcap companies are normally more unknown and don’t have long operating histories. Greater emphasis needs to be placed on qualitative attributes to form a high conviction investment decision. In addition, you will find the smaller the business the greater the impact the CEO has on the company and its future. We have written about the importance of Talking to Management [HERE] and The Art of Interviewing Management [HERE].

“If you get an opportunity to get into a wonderful business that’s being run by an intelligent fanatic and if you don’t load up, it’s a big mistake”
Charlie Munger

Beyond talking to management to see if they are capable managers, you are really looking for these intelligent fanatics. Sanjay Bakshi (a must follow ‪@Sanjay__Bakshi‪) wrote this excellent piece on Intelligent Fanatics. Intelligent fanatics are those CEO’s that have intense focus, integrity, energy, and intelligence. As Sanjay says, “(1) an intelligent fanatic has the ability to turn what looks like a poor business into a very good one; and (2) the force (I call it “fire in the belly”)” of an intelligent fanatic, when combined with a good business, has a tendency to produce what Charlie Munger calls a “lollapalooza” outcome.”

In this fascinating video interview, value investor Paul Lountzis talks about qualitative and scuttlebutt research. I would encourage everyone to view the entire interview. (@ 1 hour 10 min) Paul says:

“Companies today in many cases are becoming commoditized. Two examples are banking and insurance. They are inherently commodities; they’re not that complicated. What’s the difference? It’s the people. And the ability to find the young Phil Knight, a young Howard from Starbucks, a young John Mackey from Whole Foods, it is becoming ever more important and I don’t mean identifying one person. I mean maybe identifying that one person like a Phil Knight in 86′ that has a unique vision, drive, focus that consumes him. And as a result of him and how he thinks, he is creating a culture that is so different and unique and everlasting…. You need managements that are adaptive, flexible, creative, and innovative in a multitude of ways... This is becoming more important today because things are changing at a phenomenally rapid pace that if management isn’t like that, then you’ve got a problem.”
Paul Lountzis

If you want to understand a company’s moat and staying power you should analyze a company’s product/service and talk to industry experts and competitors. Some of this you can do by reading annual reports and exploring the internet, but for the real value add information you’re going to have to get your hands dirty and do some physical stock research.

“Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.”
Philip Fisher
So why don’t more people do qualitative analysis? The bottom line is because it is hard work. At first it is uncomfortable to visit companies, management teams, or cold call competitors, suppliers, and customers. Anyone can be taught quantitative analysis. Qualitative analysis is the real “edge” because so few do it, and it takes time and experience to do it well.

Fund manager Avner Mandelman wrote a great book on qualitative analysis called, “The Sleuth Investor”. When Avner conducts due diligence he approaches it like a detective. In the book he gives his sleuthing techniques to uncover information that can give him an edge.

“As an aside I occasionally give talks to MBA classes about Sleuth Investing (in Ivey’s business school in Canada, or in Columbia in the U.S.), and found it odd that very often, the smarter the students, the more difficult it is for them to grasp the idea of physical stock research. And even those who do, usually right away they want to computerize it, automate it, do it with databases, A.I. algorithms …What most instinctively resist is the hard work of person-to-person contact, and the use of all five senses, so as to generate an un-quantifiable, un-modellable gut feel.”
Avner Mandelman
Don’t let your entitlement handcuff your returns. Don’t be lazy. This is a competition. In a recent blog post by Ben Carlson, he talks about legendary hedge fund manager Michael Steinhardt. When Steinhardt was asked what the most important thing an average investor could learn from him, he replied, I’m their competition. If you are looking for great companies early, you want to find them before others.

Your “edge” is knowing your investments better than most. This is a must if you are going to be successful and quite frankly your fiduciary duty if you manage OPM (other peoples money). The only way to develop the Conviction To Hold is to know your positions better than most. Don’t bother finding the next multi-bagger if you aren’t going to develop the conviction to hold them. You can’t do this by quantitative analysis and surface due diligence alone. This can only be achieved by having a deeper understanding of your investments. The smaller the company the greater the impact that management has on the business. The smaller the company the more important qualitative analysis becomes. Qualitative analysis doesn’t just mean analyzing things that can’t be quantified. Qualitative analysis is looking for quality. Quality over Quantity in everything.

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Comments 8

  1. While I agree to your points in theory , the problem is in practice & execution .

    A lot of companies do qualitative research on their competitors to get an edge but increasingly fail ( this inspite of the fact they understand industry better than outsiders ) . why does that happen ?

    Behavioural bais of investigator and intention of person giving information plus understanding what one needs to know and cannot get from public information sources .

    It is an competitive edge if you can do it right but then one should guard his portfolio from competitors so that he can build sizeable position . Difficult when you are public figure . Portfolio secrecy was one of plus point of Mr Buffet in early days

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      It takes time and experience to evaluate people and businesses without your own biases getting in the way. I remember back when I visited my first companies. Here I was a 22 year old (still in college) and I was getting tours of facilities, talking to management in their boardrooms, etc. I was awe struck of this ability to meet with management, and so the first few times I left meetings way too bullish. Over time, and only over time, you learn to keep your biases and emotions where they should be, out of the investment decision.

  2. I completely agree with you. I am personally struggling with this fact. Avner Mandelman has rightly pointed out that all I want to do is to automate.

    Sometimes I find pain in co-coordinating those meetings and interviews.

    I am a firm believer that observation of body language gives you an edge and nothing can substitute this.

    I am just a month old after my studies in to this job and I feel eventually I will focus more on Qualitative data rather than quantitative data.

    I feel I got to read this post at right time. And I will re-read it occasionally.

    Thanks for this wonderful post.

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    After writing this article and listening to Paul Lountzis wonderful interview (several times), I realized that Paul’s office was only a 30 minute drive from my home. I contacted him and he agreed to have dinner with me a few days later. I want to thank Paul for being gracious enough to spend 3 hours of his day with me.

    We spoke on several topics obviously qualitative analysis being one of them. One of the most interesting parts of the conversation was when we talked about why investors don’t do qualitative analysis. Here were Paul’s four reasons with greater emphasis on #3 and #4:

    Top 4 reasons investors don’t do qualitative analysis
    1. It’s hard
    2. It’s expensive (travel, etc)
    3. Investors don’t concentrate enough to make it worthwhile
    4. Investors don’t hold stocks long enough to make it worthwhile

  4. HI Ian. I was just reading “The Warren Buffett Philosophy of Investments” and I found this passage here that I would like to share that talks about specific cases of how he does due diligence. This man is just amazing.

    Bill Gates comments that when Buffett “invests in a company, he likes to read all of its annual reports going back as far as he can” [Gates, 1996]. Buffett indeed attempts to go back as far as possible. For instance, in 1996, Buffett admitted that he had been studying Coca-Cola’s annual report for 1896 [Buffett, 1977–2013, 1996]. (In one of his essays, Charlie Munger reviews Coca-Cola’s development since the nineteenth century [Munger, 2007b, pp. 181–197].) Buffett explains his fascination with hundred-year-old financial reports: he collects antique financial reports the way some people collect vintage cars. “As with geography or humans, it is interesting to take a snapshot of a business at widely different points in time—and reflect on what factors produced change as well as what differentiates the specific pattern of development from others also observed” [cited in Graham, 1998, p. 534]. In addition to annual reports and newspapers, Buffett reads specialist and trade publications, such as Progressive Grocer, which teaches how to stock a meat department in a supermarket [Schroeder, 2008, p. 828]. He also reads Broadcasting, Property Casualty Review, and Jeffrey Meyer’s Beverage Digest [Buffett, 2003]. Buffett owns 100 of almost every stock he can think of just to be sure he gets annual reports [Buffett, 2003].
    It is not just a matter of broad research, however, extreme attentiveness to detail is also unerring. A characteristic example is Buffett’s purchase of the Texas company Star Furniture. Buffett asked for the past three years’ financial reports. Once he had examined them, he made additional inquiries. Melvyn Wolff, the then-owner of the company, recalls that one of these questions was about minor comments that the auditor had made concerning the statements for some of the years. Although the comments for each year were fundamentally the same, in one year the auditor had used a slightly different wording. Buffett noticed the difference and wanted to understand why the phrasing had been changed. Wolff remembers that he “almost fell off his chair” when he heard the question. He felt that, first, nobody would read that kind of footnote, but that even if someone did, it would be nearly impossible for that person to remember that the same footnote was phrased differently a couple of years earlier, and only a rather “incredible mind” would notice something of this kind [cited in Miles, 2002, p. 205].
    Not everything about a company can be glimpsed by reading its whole history of financial reports. Katharine Graham tells a story about Buffett’s devotion to studying the business of the Washington Post after he had bought shares in the company. Observing the production process, he spent several Saturday evenings in the mailroom. The individual papers were rolled up in brown wrappers, then addresses were pasted on them, and the wrappers were sealed shut. Later Buffett remarked that this experience “made him rethink the price of the Sunday paper” [cited in Graham, 1998, p. 550].


    Chirkova, E. (2015). The Warren Buffett philosophy of investment: How a combination of value investing and smart acquisitions drives extraordinary success. New York: McGraw-Hill.

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  5. Thanks for the write up Ian.

    Qualitative analysis as u rightly mentioned is difficult plus the investments are not that concentrated to incur expenses for the same but with time people would give it importance plus the authencity of management would be keenly looked at.

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