The larger the margin of safety the more latitude for negative conditions before you have a loss. At the same time, if expectations are exceeded, your profits will be exponentially higher. Diversification is a key component of quantitative investing.
A quantitative approach places the emphasis on analysis of the stock(s) versus analysis of the company. This approach is associated with Benjamin Graham. I highly recommend Graham’s The Intelligent Investor for those who want a deeper understanding of value investing. Or you can read my review of the book here: The Intelligent Investor Book Review.
The danger in paying too much for a good quality company is, without a margin of safety, your assumptions and forecasts have to be correct. A major problem for investors in selecting dividend stocks is knowing whether the price of the stock already reflects the quality of the company.
Here is a quote from Deep Value:
“Qualitative factors suffer from the same basic problem: It is impossible to determine the extent to which they are already reflected in the price of a given security….. the analyst should be concerned primarily with values that are supported by facts and not with those that depend on expectations.”
Tobias Carlisle
In other words, I might find a stock that passes all my 30+ qualitative and quantitative metrics for dividends, balance sheet, income statement, cash flow, profitability, and Piotroski f-score, but fail the valuation metrics by a large margin.
That would most likely indicate a quality company that may be priced for perfection (with no, or a negative, margin of safety). This might be a stock I would want on my wish or watch list to buy at lower prices. But, at current prices, it may be a terrible investment solely because the price of the stock is too high.
It’s not what you buy; it’s what you pay for it. A high quality asset can constitute a good or bad buy, and a low quality asset can constitute a good or bad buy…..the failure to distinguish between good assets and good buys, get most investors into trouble.
Howard Marks – The Most Important Thing
For the quantitative analyst this means the valuation metrics are the most important part of stock analysis. That doesn’t mean they are not important to the qualitative analyst, just not as important (they are willing to pay a “fair” price). When you find quality at bargain prices then you have an investment where the odds are heavily in your favor for an above average rate of return.
Quantitative vs. Qualitative
The quantitative vs. qualitative debate is relevant. Investors should use the approach that best fits their holding period and investment style.
In reality, all analysts use both quantitative and qualitative approaches. Both approaches have value. Your investment style and holding period might determine which one should be emphasized.
When selecting dividend stocks the ultimate goal is to find quality companies at prices that provide a margin of safety.
If you don’t have the time to do your own research, consider the Dividend Value Builder Newsletter. It will provide the information you need to make informed investment decisions.