How To Evaluate A Stock Qualitatively

Evaluate a stock before buying

When you evaluate a stock before buying, you obviously look at parameters like the P/E ratio, growth, P/BV ratio, operating margins etc. That is normal. However, buying and holding an investment for a long time is not just about such quantitative parameters but also about qualitative parameters. Now, what do we really mean by qualitative parameters. These are largely intangibles that cannot be expressed in raw numbers. However, they can go a long way in setting the valuation for the company. Here is what you need to look at for a qualitative perspective on the company for investment.

1) How robust is the business model?

That looks like a philosophical question and cannot be just expressed numerically. However, there can be some interesting pointers. If you are evaluating a mobile or digital company, is it in tune with the emerging trends in digital. In the case of pharma, is the focus still on generics or is the company into value addition. For IT stocks, is it still into traditional BFSI or has it transitioned into SMAC i.e. social, mobility, analytics and cloud. These are the kind of questions that can address the challenge.

2) Does the top management show integrity?

Before Satyam actually went bankrupt in 2009, it was a high-quality company at par with the top players. However, it never had the integrity image that the promoters of TCS or Infosys had. Eventually, there is never smoke without fire and we saw how the company ended up destroying investor wealth. Look for legacy. Companies like the Tatas, Birlas, Asian Paints have been around for decades have proven a point; that management integrity matters a lot in business. In fact, management integrity is good business sense.

As an extension to the above discussion on integrity, you can also add corporate governance. That is a focus on whether the company is putting stakeholder interest above all else. Corporate governance is when the management thinking is sync with the interests of shareholders. Issues like disclosure, transparency, management principles and consistency matter a lot in assessing levels of corporate governance. Companies that had questionable standards of corporate governance like the Jaypee group and the Unitech group faced immense price pressure when their corporate governance practices came into question. Corporate governance is a big value creator.

3) Does the business bring competitive advantages to the table?

The legendary Michael Porter said more than 30 years back that the future of business lay in creating competitive advantages. How do you create competitive advantages. It can be an entry barrier. For instance, Asian Paints has created a competitive edge with its distribution, Infosys with its execution, Maruti with its breadth of offerings and Reliance Jio by creating the ultimate digital ecosystem. Competitive advantages are also called moats and are hard to replicate. Normally, when you evaluate companies for investment, look for such moats.

4) Are there differentiating brands and intangibles?

Brands are special because they help retain market share in tough times and also offer premium valuations to the company. Brands can be a customer association that represents quality, service and reach. Hindustan Unilever, Nestle and Britannia are brands that represent quality. In banking, HDFC Bank and Kotak Bank have created a unique brand that it is possible to grow without compromising asset quality. Despite recent reverses, the customer franchise can be a huge intangible edge for Paytm.

Qualitative factors are difficult to value but they are critical in taking your final investment decision. With all financials in place, polish up your argument with intangibles.