A few weeks ago, I discussed why you shouldn’t rely on qualitative analysis for your stock market decisions. On the other side of the coin is the option of quantitative analysis. I’ll explain the philosophy behind it and provide the reasoning behind my support of it.
A quick Google search of quantitative analysis returns the definition as “analysis of a situation or event, especially a financial market, by means of complex mathematical and statistical modeling”.
Investopedia extends this definition as “measurement, performance evaluation or valuation of a financial instrument.”
It is the analysis of a financial instrument, not a situation or event that we are most concerned with. A financial instrument is simply an asset that can be traded like a stock or bond.
So what’s the point of being able to find the valuation of a stock? Will quantitative analysis really assist in finding stocks that will increase in value on average more than they decrease?
To answer that question, we must look at the basics behind a security (or stock).
A stock simply represents part equity in a business. Equity means an ownership stake. So, to understand the basics of a stock, we must understand the basics of the business behind it.
The primary goal of a business is to turn a profit. All of the complicated moving parts surrounding the business world and the corporations inside eventually circle back to this chief point.
There are many strategies behind doing this, and some companies delay turning a profit in the present to expand the business quickly, but the final end goal resides with turning a healthy profit.
Other elements of the business, such as assets on the balance sheet (property, buildings, equipment, etc.), are acquired to assist in creating revenue.. Which turns into profit.
I hope you can understand my point. There’s plenty of complicated jargon, industry specific metrics, and accounting details that could possibly involve quantitative analysis. But it always comes back to the most important question, if the company is making a profit. [click to continue…]