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Sunday, March 5, 2017

Qualitative vs Quantitative analysis? Which is more important?

Quantitative analysis is about analyzing the facts and figures from the financial statements to derive a fair value on the company stock whereas qualitative analysis is about analyzing the business model and non-arithmetic aspects of the company and its industry to assess the feasibility and sustainability of the company.

Many financial analysts focus on quantitative analysis and neglect the qualitative aspects which often result in misjudgments.

For example, financial analysts like to tout shipping trusts to retail investors as value investment instruments because of their constant distribution yields that are akin to bond yields or fixed deposits.  They always use quantitative analyses to justify for buying shipping trusts due to the long-term chartered contracts (7-10 years) and high distribution yields of 5-7%.

However, if we use qualitative analysis on shipping trusts, we will discover that shipping trusts cannot withstand economic downturns and recessions.  The business model of shipping trusts is based on ship acquisitions to secure ever rising chartering rates to maintain the high distribution yields.  The acquisition limit is usually restricted by its loan-to-value ratio rule that is around 70%.  In a nutshell, the bank will only loan up to 70% of the ship value.  Although shipping trusts usually require their customers to lock in long-term chartering contracts of between 7-10 years, the customers won’t honour these contracts during economic downturns or recessions because many of these customers cannot survive such hardships.  When the customers start to breach these long-term contracts, shipping trusts are left with an oversupply of ships that are berthing and doing nothing.  Then, the shipping trusts will be forced to sell the idling ships at lower rates and these ship values will decline significantly.  Banks are usually cognizant of the latest developments in the shipping industry and will demand the shipping trusts to top up the differences in the fallen ship values.  Conversely, some banks will even recall the ship loans to cut down their risk exposures to the shipping industry.  All these events will start a vicious cycle in the shipping industry, which will lead to tremendous fall in shipping trusts’ prices and distribution yields.  However, many financial analysts will omit these cold hard facts and information to the retail investors by not doing a proper qualitative analysis.

Therefore, you better think twice when you read analysts’ reports without proper qualitative analyses.

1 comment:

Eric Ho said...

To recap, shipping reits will face lowering chartered rates and falling ship values during economic downturns which are the achilles' heels.