Long term investment Tips for qualitative and quantitative analysis

Does investing work?

Think of a plant that is given the necessary water, manure and attention. Will it not thrive? The same applies to businesses with good sales figures, generous margins, inventive products and exemplary management. Surely the share price of such firms will rise. 

Sometimes this progress may be deferred, but it is bound to happen eventually. This has been demonstrated time and again in various markets across the world as well as India.

Investing in a good company defined by investable grade attributes will always yield results. However, one needs to be able to handle short-term market volatility.

–  What do investible grade attributes mean? 

We briefly discussed the characteristics of an investable grade company in the previous chapter. These characteristics can be categorised under two categories: the qualitative aspect and the quantitative aspect. 

When evaluating a fundamentally strong company, both of these aspects must be studied. My personal investment practice focuses more on the qualitative aspects than the quantitative aspects.

The Qualitative aspect involves understanding the non-numeric aspects of the business. This includes factors such as:

1. What is the background of the management– Who are they, what is their background, their experience, their education, are they qualified to run the business? Are there any criminal cases against the promoters?
2. What are business ethics – One needs to see if the management is involved in any kind of scams, bribery, and unfair business practices.
3. Corporate governance – Appointment of directors, the structure of the organisation, transparency, etc.
4. Minority shareholders – How does the management address the concerns of minority shareholders? Are their interests taken into account during corporate decision-making processes?
5. Share transactions – Is a clandestine promoter group buying or selling shares of a company on behalf of the management? 

To give you a context, a clandestine promoter group refers to a secretive or hidden group of individuals who have a significant influence or control over a company, often behind the scenes. These individuals may hold a substantial stake in the company’s shares or have strategic positions within the organisation. The clandestine nature of this group implies that their involvement may not be publicly known or easily discernible, and they may operate in a covert or undisclosed manner. Their actions and decisions can impact the company’s operations, financials, and corporate governance, potentially influencing the interests of other stakeholders, including minority shareholders.

6.           What are the related party transactions – Is the company offering financial favours to known entities, such as the promoter’s relatives, friends, vendors, etc., at the expense of shareholders?
7.           What are the salaries paid to promoters – One needs to check if the management is paying themselves a hefty salary, usually a percentage of profits, to promoters.
8.           Operator involvement in the stock market- Unusual price movements occur when the individual promoting the stock is involved in buying or selling the shares.
9.           Shareholders – The company’s significant shareholders are the people who own more than 1% of its outstanding shares
10.         Is there any political affiliation –Does the company have a strong affiliation with a particular political party? Does the business rely on ongoing political backing for its operations?
11.         Promoter’s way of living- Do the promoters exhibit excessive flamboyance and a tendency to flaunt their wealth?

A red flag should be raised when any of the above mentioned factors are out of place. 

For example, if a company has an excessive number of related party transactions, this raises suspicions of foul play and is not beneficial in the long term. Even if it initially has attractive profit margins, any questionable behaviour will eventually be exposed, causing the stock price to drop significantly. 

Therefore, investors should exercise caution when investing in companies with superior profits that score poorly on corporate governance.

Unearthing qualitative aspects can be challenging as they involve nuanced elements that are not easily detectable. We will highlight various qualitative aspects as we progress through this module. However, a diligent investor can easily figure this out by paying close attention to the annual report, management interviews, and news reports.

Some of the quantitative aspects are straightforward, while others are not. They are related to financial numbers. The stock markets pay a lot of attention to quantitative aspects. For example, cash held in inventory is straightforward, but inventory number of days is not. It is a metric that needs to be calculated. Quantitative aspects include many things, for example:

1. Profitability and its growth
2. Margins and its growth
3. Earnings and its growth
4. Matters related to expenses
5. Operating efficiency
6. Pricing power
7. Matters related to taxes
8. Dividends payout
9. Cash flow from various activities
10. Short-term and long-term debt
11. Working capital management
12. Asset growth
13. Investments
14. Financial Ratios

Each sector has its metrics. For instance:

In the next few chapters, we will look at how to read the basic financial statements contained in the annual report.