To The Moon

Some investors swear by using a quantitative approach to investing while others believe that numbers are less important when compared to qualitative analysis.

Each has its valid concerns. The quants believe that humans are full of biases and it is not possible to overcome them easily unless one is to makae investment decisions based on numbers alone.

But to the qualitative tribe, they believe that numbers are historical and not predictive of the future. You need to make a judgement call on how the future will turn out in order to make a good investment decision today.

Whenever you see conflicting views online, it is important to know the context that they are making those views. Otherwise you will feel lost and confused or worse, adopt a view and apply it in a wrong context.

Allow me to shed some light on the contexts. I do three strategies; momentum, value and growth; so I will use these to explain.

An investor who focuses on cheap stocks is likely to pay more attention to valuation. He can afford to be quantitative as value stocks generally do not need any future projection because it is already underpriced based on today’s value. The potential return is based on how cheap you buy a stock and not how much it will grow. Historical numbers are good enough.

In fact, many of these cheap stocks are unglamorous stocks. Using qualitative analysis would have easily dismissed them as junks. A good study was conducted by Joel Greenblatt (a hedge fund manager) who came out with the Magic Formula (a quant value strategy).

He offered his clients two ways to utilise this strategy. First, blindly invest according to what the strategy says. Second, choose and pick what the client wish to buy from the list.

The results after a few years showed that the first group did much better than the second because they were less biased.

Similar to momentum strategies, I realised many people aren’t comfortable buying at the one-year highs or all-time highs. They think it is expensive. But in the short term, valuation is not important, what is expensive can be even more expensive and the reverse is true too.

Hence, just remember this: any strategies that do not need forward projection to make an investment decision, focus more on the quantitative aspect to minimise the impact of biases.

If you are still not convinced numbers alone are good enough, think about index investing - it is pure math and zero qualitative analysis, and it is able to beat majority of finance professionals and retail investors out there.

However, quantitative analysis will not work well for growth investing. This is because the future numbers are unknown yet. We do not have year 2030 financial statements of a company today. Many numbers that analysts try to use are guesses and guesses aren’t accurate enough.

Hence, valuation is going to be fluffy. Even if you get the valuation right but the growth prospect wrong, you can still lose money. So more importantly is getting the growth prospect right.

This is where qualitative analysis shines. Although prone to biases, this is still the best way for growth stocks. They are about the future and you get rewarded by making an accurate judgement about how the future would turn out. This cannot be done by numbers.

So there you go, the disagreements do not mean that someone is wrong. They can both be right, but in different contexts. Most importantly, apply the right approach in the right context.