How to Quantify Quality
Someone who reads the blog sent me this email:
I kind of understand the quantitative part of stock analysis (such as number crunching, valuation) but really struggle to understand the qualitative aspects which determine quality. What kinds of questions to ask yourself in order to gain more insights into the qualitative?
A qualitative analysis does not have to be any less evidence based than a quantitative analysis. However, you do have to gather the evidence yourself.
What counts as evidence? How can we separate our own biases, speculation about the future, etc. from actual observations of quality? Evidence is fact based. Facts come in several flavors.
Number
Example: Tiffany’s New York Flagship Store had $305.54 million in sales in 2012. That is $6,671 per square foot. Based on calculation made from data given in Tiffany’s 10-K on percentage of sales at flagship, worldwide net sales, and gross retail square footage of flagship.
Quote
Example: John Wiley, Reed Elsevier, Springer, etc. have bargaining power with their customers.
The largest (academic journal) publishers wield the power…as a former colleague of mine once said, ‘the more journals you have, the higher your usage stats are and the more money you can charge.”
Based on discussion with a university press editor.
Anecdote
Example: Over the last 10 years, I have placed an average of one order every 4 to 10 days with Amazon. At no point in the last 10 years, have I ever made less than one order every 10 days. I have been a member of Amazon Prime since 2006. The number of orders made each year has roughly tripled from 2003 to 2013. It doubled after I became a Prime member.
Based on information found in my own order history for 2003 to 2013 at Amazon.
History
Example: The 4 most successful periods in animation were at 3 companies: Disney (twice), Pixar, and DreamWorks. At the time of their success, these companies were run by Walt Disney, Jeffrey Katzenberg, John Lasseter, and Jeffrey Katzenberg (again). All worked at Disney at some point in their career.
Based on more than half a dozen books on Disney, Pixar, and DreamWorks.
Experiment
Example:
377 participants were assigned to (Weight Watchers), of whom 230 (61%) completed the 12-month assessment; and 395 were assigned to standard care, of whom 214 (54%) completed the 12-month assessment. In all analyses, participants in the commercial programme group lost twice as much weight as did those in the standard care group.
Based on a journal article appearing in The Lancet.
As you can see, there is no need to be less evidence based when analyzing a business’s quality than you are when analyzing its price. However, you have to impose an evidence based discipline on yourself. You have to go through the primary sources and extract the relevant facts on your own. They will not be presented in as easily digestible form like an EV/EBITDA ratio on Yahoo Finance. When it comes to quality, you need to gather the evidence yourself.