Qualitative and Quantitative Analysis
When looking at stocks, you can do a qualitative or quantitative analysis. Qualitative analysis is done by looking at the company’s business and market factors: Is it growing? Is it well-run? What is its competitive position?
Quantitative analysis looks at a company’s financial statement and tries to predict future trends and the company’s health: Is it making money? Is it generating a significant amount of free cash flow? Are sales growing or declining?
In most cases, you should be doing a combination of both analysis methods … but if you have limited time to to do stock analysis and you need to decide quickly on a company’s health and potential, you should focus on doing a quantitative analysis.
What Does a Stock Quantitative Analysis Look Like?
You might be surprised to learn that most quantitative analysis boils down to simple accounting techniques (unless it’s for very complex financial products like derivatives).
You can do a quantitative analysis yourself or you can outsource it to an investment bank that’s in charge of it on a daily or weekly basis.
Here’s a quick overview of what a quantitative analysis might look like:
Use Quantitative Analysis
Qualitative analysis involves analyzing the factors that contribute to the success or failure of a company with a qualitative approach. It goes beyond what the financial statements can show you and goes straight to the heart of the matter. that is, the company’s core competencies.
Quantitative analysis uses large volumes of data to evaluate trends. And, uses the financial statements to calculate ratios to identify and examine those trends. This approach requires numbers.
The goal is to produce data that helps you make sound, educated decisions.
Before you get started analyzing a company, you have to first decide on what aspect of the company you will focus on. Questions to consider may include:
- How should I identify and prioritize the important financial factors?
- How do I do I evaluate each financial factor in order to measure a company’s success or failure?
- What information do I need to make the proper conclusions?
Key Financial Ratios When Buying Stocks
When deciding whether to buy a stock, it’s important to examine key financial ratios that show how profitable the company is compared to its industry. A great way to do that is to use stock ratios. These provide an overall picture of whether an investment is a good one or not for you.
Here is a review of some of the most common financial ratios used to evaluate a stock. These can be used by both long-term holders and investors.
P/E Ratio
This ratio shows the company’s perceived market value compared to its earnings per share (EPS). The P/E ratio is calculated by dividing the current stock price by its EPS. It gives investors a quick way to compare the stock’s value to other stocks.
Price-Earnings to Growth Ratio (PEG)
This ratio of P/E to growth ratio gives shareholders a better idea of how the company is doing based on price and earnings growth. PEG is calculated by dividing the current stock price by the EPS growth for the past year. The lower the PEG number, the better, because a company with higher P/E and low earnings growth is seen as overpriced.
Price-to-book Ratio
Stock Ratio Categories
Right off the bat, it's good to differentiate between measuring companies on a "P/E" basis and evaluating stocks on a "VaR" basis.
VaR is an acronym that stands for volatility-adjusted return, and it's used to measure risk in a "what-if" scenario. Using a VaR number is good for analysis when you don't know the capitalization of your company. Some people use VaR to monitor growth over a long period of time.
P/E ratios, which stands for price to earnings, are used to measure a specific amount of growth in a specific amount of time. The ratio is used when you know what your company's capitalization is.
The P/E ratios you may be familiar with are:
P/E = Current Stock Price (CSP) / Stock Price 3 Months Ago (SP3M)
The P/E represents the ratio of the current stock price to the stock price three months ago.
The P/E, as you may have guessed, is a measurement of price to growth. Another P/E is the ratio of the current stock price to the stock price 12 months ago, and yet another P/E can use the current stock price and stock price six months ago.
Valuation — Price to Earnings (P/E)
P/E is the most commonly used stock valuation metric. It is used to compare a company’s stock valuation to its actual earnings – to see whether the stock is trading for a good or bad price.
The main significance of the P/E ratio is to compare how much investors are paying for their earnings in the form of dividends or stock price. In essence, it is a measure of a company’s normalized earnings per share, and divides a company’s current stock price per share by that company’s earnings per share for the past year.
The result is expressed as a multiple of earnings with no significance to what the multiple is when evaluated on a relative basis. The resulting multiple is simply relative to the earnings of the firm – who is trading at a multiple of 10 compared to a firm trading at a multiple of 20.
A reasonable P/E ratio should be a multiple of 15 to 25, and the price should be at or above the industry average.
Valuation — Price to Earnings Growth (PEG)
This ratio shows how risky a stock is, compared to its growth.
It is calculated by dividing the P/E ratio by the growth rate, both expressed as a percentage. A portion of the P/E ratio could be subject to growth or it could be the growth rate itself, depending on the type of stock in question.
Any number greater than 1 is considered overvalued.
A lower figure or number is preferable because it means the stock is undervalued and is therefore a good investment.
Valuation — Price to Sales (P/S)
The price to sales ratio is calculated by dividing the company’s share price by its revenues (revenues = sales, and sales = total sales of products and services). Sales are just another name for net sales, so what you’re dividing is the fund company’s market cap by its revenues.
Price to sales is also known as the “price to revenue.” Calculated as share price/revenue, it’s not a very evocative name – revenue is an accountant’s word, not a marketer’s. On the other hand, it’s much more intuitive than price to sales and most people know what a salesperson does, so you need to decide whether the intuitive or evocative name makes more sense to you.
Valuation — Price to Book (P/B)
The price to book ratio (P/B) is a metric that investors use to measure a company’s stock valuation. When people first start picking stocks, they usually use fundamental analysis to do this. In addition to looking at a company’s financial performance, they analyze the balance sheet and income statement to see if there are any problems. Accounting data helps to examine a company and its stock valuation.
But gauging the valuation of equities is useful for more experienced investors. Using price to book (P/B) ratio is a common way to determine if a company’s stock is over- or under-valued. Just by looking at the stock and its price, you can get an idea of whether it’s fairly valued or not.
Valuation — Dividend Yield
In order to have a strong, long-term investment strategy, you need to look at stocks as business investments. Too many amateur investors attempt to predict the direction of a stock. Although this may be possible in a perfect market, it is not a game that the average investor can win.
Predicting future price movement is nearly impossible. Professional investors realize that focusing on future price movement is a waste of time. Instead, they focus on how much money they can make from the stock today.
Predicting interest rates is nearly impossible. Professional investors realize that focusing on interest rates is a waste of time. Instead, they focus on finding investments with high-yield potential.
In order to find high-yield potential, you need to focus on the fundamentals. The key fundamental to those who are interested in dividends is the dividend yield.
Dividend yield is the ratio of dividends to the price of a stock. The higher a dividend yield, the lower the stock price must be to produce a higher return.
Earnings yield is the ratio of the forward earnings estimate to the price of the stock. The higher an earnings yield, the lower the stock price must be to produce a higher return.
Valuation — Dividend Payout
Profitability — Return on Assets (ROA)
Return on assets (ROA) is a key ratio for evaluating a stock. It is one of the most frequently reported financial ratios, and is used to help determine how well a company is using its assets to generate earnings or returns. This ratio is calculated as follows:
Return on Assets (ROA)% = (Net Income — Dividends) / Assets
ROA is considered one of the key financial ratios of profitability. Return on assets gives the investor a good indication of how well the company is making use of its assets to increase earnings. A company with a high ROA is simply more effective in using its assets to increase earnings, than a company with a low ROA. It is a financial ratio that is used for a large number of industries that include banks, insurance, and manufacturing, among others.
Profitability — Return on Equity (ROE)
A company’s earnings are often divided between common shareholders as dividends and undistributed earnings. For ROE to truly tell you how profitable a company is, you need to remove undistributed earnings. You can look up most companies’ annual reports and see how much of their earnings were distributed to shareholders.
Since this is not a very commonly available number, most people look at the “retained earnings” number. This number is the sum of undistributed earnings and earnings from the previous year. To calculate ROE, simply divide the net income available to common shareholders for the year by the company’s total stockholders’ equity.
If you see a low ROE for a company you weren’t planning on buying, but you see a high ROE for one you were, that would be a good reason to reexamine your portfolio.
Profitability — Profit Margin
Interpretation: Is this business making a profit? In the example above we find that the net profit margin is low relative to other businesses in the same industry and price range.
How to interpret: In this case the company has a net profit margin of about 5.4%, which is lower than the median for companies from the same industry and price range. This necessitates additional research into this company or investing in other companies in the same sector.
- Please note that these are estimates only, and may not reflect current prices and/or financing rates.
- Volume (share/financial data)
It Is Perhaps the Most Significant and Important Factors Determining the Future Growth of the Stock and The
Company, adjusted by debt ratios.
It is also used for analysts’ and traders’ calculations.
Liquidity — Current Ratio
When evaluating venture capital stocks, there are various stocks ratios that you need to keep track of. Liquidity is one of them.
The current ratio, also known as the quick ratio, measures a business’s ability to pay its short-term debt obligations, in the event of liquidation.
A higher current ratio is preferred to a lower current ratio.
Look at a business’s current ratio by dividing current assets by current liabilities.
Current assets: cash, cash equivalents and short-term investments, plus accounts receivable, inventory and prepaid expenses
Current liabilities : accounts payable, salary and bonus payables and short-term debt.
Not every company is going to have the same amount of current liabilities, so to calculate the ratio, you will need to add all the current liabilities and divide by the total current assets.
The higher the current ratio, the better.
The Numbers Tell a Story
When evaluating the market, you need to look at a lot of different variables and numbers to see what’s going on in the world. Let’s look at some of the numbers that you will get when you start to look at stocks and market ratios.
First, you need to look at the earnings per share. This shows you what each share in a company is earning in a given year. The symbol for earnings per share is “EPS,” and you usually get two numbers from EPS, and that is “basic EPS” which does not include the effect of any stock options that were granted to the company’s officers or employees. The other number you see is “diluted EPS” which includes the effect of the stock options. Diluted EPS is more commonly used when talking about the earnings per share of a company. It is also important to know the trend of this earnings per share over the last few years.