Ep 56: 3 Basic Qualitative Stock Picking Factors

3 Basic Qualitative Stock Picking Factors

In episode #56, we will share with you the major qualitative factors that you must examine before determining your investments in the stock market. Investing is not simply a scientific numbers game, understanding who is running the business, how scalable are they, and what are some advantages they have over their competitor competitors can greatly improve your investment returns.

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podcast Transcript

There are 3 qualitative points that I look at before deciding which stocks to pick.

Is stock picking an art or is it a science? That is the endless question. And I believe it’s a little bit of both. Yeah, very, very cordiall answer, but it is true. Some things, you can qualify some things you can’t qualify. And that is an inevitability of investing. 

Because humans are humans. They always make interesting things, interesting moves. Some things you think are doomed, no choice, but suddenly there is a turn around and things happen. So, yes, today, I’m going to share with you 3 qualitative points that I look at when picking stocks and whether you pick stocks yourself, I think these are good things to learn. It gives you a much clearer understanding of what you’re actually investing in. 

Even if you invest in ETFs, robo advisors or unit trusts, most of them have underlying stocks and equities within them. If you can spend a little bit of time to go and read up on them, It may help you in your investment journey, even with picking ETFs, or just being more comfortable with what you are investing in. 

Because underlying most of them are stocks, bonds, gold. You know, you get it right. These are fundamental products in terms of investing. And to that one guy that gave me one star on Apple podcast. I think he had some problems with one of my earlier episodes, which was also about stock picking.

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One of my main pointers that I presented was the element of luck. I stand by this point, if you cannot handle that investing has some element of luck, you will probably never be a good investor. It is because you can comprehend that there are things that you cannot control, and under the broad umbrella of luck as a concept.That is when you know how to size your bets, you know how to hedge and you become a better investor. If you believe that everything can be calculated and everything can be controlled, then you live in a simulation or you don’t live in a real world.

Today we’re gonna dig deeper and embrace all these kinds of uncertain elements, which are mostly qualitative because a lot of times quantitative pointers like matrices, calculation, is at the forefront. A lot of people look at those things. I think that is a fair start to look at revenue, to look at cash flow. Look at all those things that are in the balance sheet that are calculable. 

Those are easy things because when it comes to quantitative stuff, there are hardlines. You only take something at 5%, you only, blah, blah, blah. You set all these different matrices that you’re comfortable with, that fits your investment strategy and you follow them. Most people do that. But when it comes to qualitative, which is why we’re going to talk about it, there are no numbers. It is a lot of intuition, your understanding of the sector, understanding of the market, understanding of all the different matrices. It becomes a little bit more complex. 

I’m not saying that after listening to 20 minutes of a podcast, you can suddenly comprehend all these qualitative factors. In fact, I think every one of them requires an episode on their own, but I decided that we should start somewhere. We’re just going to make it easy. And I’m going to give you all these different pointers that you may need to continue to do some research on your own. 

The goal of today’s podcast is to give you a place to start. After you recognize these things, you can continue your reading, continue to learn and continue to find your comfortable way of investing. 

  • Management 

The saying goes tough times don’t last, tough people do. And in some ways it is true. There are amazing management teams that can turn around problems and double down on growth opportunities. Everybody has their own preference, much like choosing a boyfriend or girlfriend. 

Everybody has their own things that they like. So I’m not going to go too much into the likeability factor. The way they talk, the way they present, all those kinds of things – depending on your own way of life, your own preferences, you have your own views. So some people may like the person that is drilling holes under the ground and sending rocket ships. trying to build some electronic vehicles and the share price keeps increasing.

So management would include people like your CEO, CFO, COO and CTO. So finance, operation, and technical. You definitely have to look at these aspects of management. I will give you a few questions to help evaluate the basic structure for management. 

Is this company led by founders? When something is led by a founder, there’s personal interest beyond just monetary. Founder-led businesses tend to be a lot more aggressive in terms of growth. They are more passionate about what they are trying to do. But recognize that sometimes founders are not able to take the business to another level. Not everybody can be like Zuckerberg. Some founders cannot transit and it’s okay. You just recognize it. Most of the time they will move on and pass the baton if they cannot transit. 

For those that can transit, there is a lot of power in terms of being led by the founder, the passion, the drive to make it work beyond just monetary success. Other things to look at would be whether they have relevant experiences. Have they been in the same sector? Have they managed a company of a similar scale. Let’s say the company is trying to go into a whole new direction. Starbucks wanting to go into an IT-focused business with digital payments, reward systems. That was when Howard Schultz stepped down.

He pushed for the new CEO, Kevin Johnson, who was a techie from Microsoft. Everyone was questioning it. But if you think about it, it’s aligned with what Starbucks was trying to go towards. Digital payment, on-demand delivery, reward systems that are technically heavy. 

You bring a tech guy to lead the business that gives them the insight and the power. So yes, relevant experience is important. Whether it is relevant to where the company is or where the company is trying to head towards. I think top management need to have a relevant understanding of which sector, which growth opportunity they’re trying to capitalize.

I think one of the other points you can look at when assessing management is whether or not they are consistently meeting the goals every year. Based on the annual report, they will tell you some of their goals, whether it’s mid-term long-term, or even goals for this year.

I tend to like management that are able to consistently meet goals or even supersede their goals. Because then that gives me comfort to know that whatever the management says, they will do it. And it’s not just talk, for the sake of it, or over-hyped goals or capacity.

I personally want to have the kind of comfort to know that I can trust the management, that they always meet their goals. So these are some things that you can definitely consider when understanding the management. And to end off the discussion on management. I think that one thing that we all can better understand, is that if a company is struggling, that means they have consistently struggled for a few years. Sans COVID, businesses that are getting challenged constantly, without a change in management style, ideas, without a turnaround. The chances of it turning around and growing again is close to zero. 

Same bunch of people, managing the same way, with the same strategy. What do we expect? Every time when a company is not doing well, or they have experienced extended prolonged regression, I always want to see a change in management, at least a few of them at the top.

  • Business Moats/ Economic Moats 

If you understand these moats, you get a clear understanding of the value of the business beyond just how much money they are producing. So what is a business moat/ economic moat? Essentially, it is a protection around the business. What is a moat? A river around the castle. So when you say something has a business moat or has a strong business moat that means, the business has certain elements that give it an edge above its competitors. Resilience and sustained business strength. 

So in simpler terms, when we say something has a business more than a company has a business moat, essentially this means they have a certain advantage over its competitors.

So today I’m going to share with you some common business moats that you can use to benchmark against the stock or the company that you’re trying to pick. Of course, along the way as markets develop, as businesses develop, they’re more and more different kinds of moats, but these are some fundamentals that have been around for a really long time.

The first business mode is of course pricing power. If a company has a very strong brand or certain patents, it’s unique, has a strength, then it can continue to charge very decent prices. Which is what we call pricing power. If something becomes like a commodity like wifi.

There’s no more pricing power. Or like airlines, there’s no pricing power because there are always cheaper choices. reality is wherever cheaper you go. 

You want to go for things that have pricing power and can continue to charge a decent price. That usually hinges on them having a patent or being a very unique provider in the space as monopolies or oligopolies. Or they have a very strong brand that allows them to price like Apple or Nike. 

The next will be what we call brand loyalty. And there can be many reasons why someone is loyal to a brand. It can be because of high switching costs, take Apple for example. If you use everything, Apple, and now you want to switch to Android. Or it could be because they find a lot of comfort in the brand quality. Every time you think of bubble tea, you think of Gong Cha or Koi. There are 101 reasons why people are loyal to a certain brand, but we want to observe that the brand, the company, has that kind of brand loyalty. Where people keep using what they are selling. 

Which brings us to the next business moat that is economies of scale. If a company is big enough, they can produce more at a cheaper rate. So if they can produce cheaper than their competitors, they can essentially charge lower and be more dominant in the game. Or they can have higher margins, make more profit and essentially have more margins to play with.

Which is why the big businesses can continue to be bigger on many, many levels, because one of the main things is they just produce cheaper than other players can. And that definitely is a very important business moat. 

And the next business moat is this thing called the network effect. Essentially, when more people use it, more people want to use it. Something like Facebook. Imagine you use WeChat, but you have no other friends using it. You sign up just to talk to two friends. After a while you just stop using it. Much like how I started using Telegram. Overtime, as there are more people moving to Telegram, I just feel more inclined to use it

And that’s the power of the network effect. I’m not sure if you remember the beginning of PayLah! Me and my friends used WeChat Pay when we were abroad in China, and when we came back we saw PayLah! seems to be something similar. We wanted to use it, but as we used it, we realized, that no one is using it. Merchants are not taking it. Your friends are not there. Nobody is using PayLah! so who are you trying to pay?

But over time, as more and more people use PayLah! Also because of COVID where people try to be more hygienic, more hawkers are open to PayLah! It became a bigger network. You can use PayLah! everywhere now it becomes a predominant way of payment.

For another company to come in to challenge this network effect, they got to have a bigger network than PayLah!. So that’s why in the view of PayLah!, they have some dominance in the game. They have this business moat of network effect.

Of course there are many, many different business moats. I gave you some of these so that you can go and Google, learn and search more about pricing, power, brand loyalty, economies of scale and network effects. Of course, the business moats are always evolving, 

if you find other things that you think are a business moat, definitely share them with us on our Telegram group. One newer business moat is called big data. Essentially it refers to you having information about your customer. If you have more information about your customers, then you can better provide them the service and the product that they’re looking for.

Whatever it is fundamentally, you want to make sure that the business that you are buying into has some of these business moats. And if they don’t you got to question yourself. Is it because they are going to ultimately have these business moats and they are growing really fast. You have to evaluate for yourself. 

  • Scalability Factor 

Of course it depends on your investment strategy. What are you looking for? So depending on your investment palate, you want to see whether the business that you buy is highly scalable or not. Scalability just means how fast the company can grow, how much they can grow, the room for growth. 

If  we say something is very scalable, then there’s a lot of room for growth. If we say something it’s not so scalable, then it has probably reached its limit. It cannot grow any further with ease. So something with very low scalability would be like a consultation service. There’s only so many hours you can sell compared to a product. You sell a course you can keep selling. Something that is more scalable is a course while something that is not so scalable is consultation. 

But of course there are 101 ways to scale a business. And when you look at it across the board, across all the businesses, that you can easily buy in the market. Businesses that are highly scalable tend to be low capital and highly replicable. They are asset light, they don’t need you to pump in more money to grow the business. They tend to be things like software in the tech space or franchises. It makes them a lot easier to grow. Just sell more, keep opening another store because there is a system. So these are models that are more scalable. Certain sectors are what we call low scalability sectors are things that are very capital intensive, take a lot of money to build another production line, or it takes a lot of money to build like a whole network structure, like a 5G network, or highly regulated spaces.

Utilities and or telecommunications, or your airlines. These tend to take up a lot of capital to grow. And of course there are those in between like consumer goods. Yes. Some additional capital to grow because you need to produce more but not as much compared to utilities or airlines. 

I’m predominantly a growth investor. So I want to go for companies that have higher scalability factors so that they can keep growing and their share price can reflect the business growth. Whereas others that are more dividend-based, have lower-scalability factors as it is tougher to enter the space. Because capital intensive and highly regulated, things like utilities or electricity, water, railways. There are different kinds of investment for different people. So fundamentally you need to know what you’re looking for, looking for a dividend strategy or a growth strategy. 

Once again, you cannot learn everything at one go. And I know today’s episode is very packed. There are a lot of things in today’s episode because I just want to use this as a benchmark to kickstart the idea of qualitative understanding for different stocks. And it can be pretty intense. If you have lasted all the way to where you are now, congrats. Keep learning, keep growing.

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