Monday, 30 November 2009

Future expectations can be approached in two different ways: Qualitative or Quantitative approach

According to Benjamin Graham, the current price reflects both
  • known facts and
  • future expectations
was intended to emphasize the double basis for market valuations.

Corresponding with these two kinds of value elements are two basically different approaches to stock analysis. 

Every competent analyst looks forward to the future rather than backward to the past, and realizes that their work will prove good or bad depending on what will happen and not on what has happened.

The future expectation itself can be approached in two different ways, which may be called:

  • 1.  the way of prediction (or projection) and
  • 2.  the way of protection.


1. The way of prediction (or projection)

Those who emphasize prediction will try to anticipate fairly accurately just what the company will accomplish in future years - in particular whether earnings will grow rapidly and consistently.  These conclusions may be based on a very careful study of such factors as
  • supply and demand in the industry-
  • or volume, price and costs -
  • or else they may be derived from a rather naive extrapolation from past growth into the future. 
If these authorities are convinced that the fairly long-term prospects are unusually favourable, they will almost always recommend the stock for purchase without paying too much attention to its current price.

This first, or predictive approach, could also be called the qualitative approach, since it emphasizes prospects, management and other nonmeasurable, abeit highly important factors that go under the heading of quality.


2. The way of protection.

By contrast, those analyst who emphasize protection are always especially concerned with the price of the stocks at the time of study.  Their main effort is to assure themselves of a substantial margin of present value above the market price - a margin large enough to absorb any unfavourable developments in the future.  Generally speaking, therefore, it is not so necessary for them to be enthusiastic over the company's long-run prospects as it is to be reasonably confident that the enterprise will get along.

The second or protective approach may be called the quantitative or statistical approach, since it emphasizes the measurable relationships between selling price and earnings, assets, dividends and so forth. 

Incidentally, the quantitative method is really an extention into the field of common stocks of the viewpoint that security analysis has found to be sound in the selection of bonds and preferred stocks for investment.


Choosing the "best" stocks is a controversial one.

In Benjamin Graham's own attitude and professional work was always committed to the quantitative approach. 
  • From the first he wanted to make sure that he was getting ample value for his money in concrete, demonstrable terms. 
  • He was not willing to accept the prospects and promises of the future as compensation for a lack of sufficient value in hand.

This has by no means been the standard viewpoint among investment authorities; in fact, the majority would probably subscribe to the view that prospects, the quality of management, other tangibles, and the "human factor" far outweigh the past performance records, the balance sheet and all other cold figures.

Thus this matter of choosing the "best" stocks is a controversial one.

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