Qualitative and Quantitative
Stock Ranking Systems

Part 1 described the basic concepts of stock ranking systems and provided some examples. Now we discuss the types of systems you can access.

Quantitative Stock Ranking Systems

All the approaches described in Part 1 are quantitative. Judgment is used to create an algorithm which is implemented in a mechanical, repeatable fashion. Only measurable variables or those which can be quantified are considered.

Perhaps the best known quantitative systems are Valueline and Zachs. They are proprietary systems but the stock screeners associated with these systems give you access to these stock ranking values.

Qualitative Ranking Systems

Most of us are familiar with the role of the stock analyst at an investment firm. Their job is to study a company's financials, management of the company, strength of the product line and market, and produce a recommendation about the worth of the company as an investment. This is an example of a qualitative rating.

Notice that many of the variables being evaluated are not quantifiable. This would therefore be based on the judgment of the stock analyst.

One of the best known qualitative stock rating systems is the Standard and Poors' rating system - STARS (STock Appreciation Rating System). If you use an online broker, you will probably be able to access an S&P report of a company you are considering. Many of these S&P company reports will have the STARS (1 to 5) within the report along with the analysis and target price.

Qualitative or Quantitative?

The choice is yours.

• Proponents of quantitative ranking suggest that qualitative ranking is too human (subjective) and susceptible to confirmation bias.
• Proponents of qualitative ranking affirm the need to go beyond numbers to correctly analyze a company.
• Some are proponents of combining the approaches. First, limit the companies to be analyzed using a quantitative system, then do the qualitative analysis on the remaining stocks.

The last approach is similar to one mentioned by Mark Hulbert in a MarketWatch post dated October 29, 2002.

Hulbert had tracked both the quantitative approach of Valueline and the qualitative approach of STARS from 1989 to 2002. He had high praise for both but pointed out that Valueline top-ranked stocks had outperformed top rated STARS stocks by 3% per year over that period. Although he had not backtested the idea, he mentioned that it might be profitable to buy only stocks that were top ranked by both systems.

Conclusions

Using a stock ranking system to enhance your investing performance seems like a no-brainer but you need to do some research and/or back-testing before jumping in.

There are some considerations:

• Precision - The results can only be as good as the worst measurement. Back-test to determine some reasonable expectations and confirm you can improve.
• Data Mining - Torture the data long enough and it will confess to anything. Exact results are not possible.
• Past performance is no guarantee of future performance.
• Quantitative ranking relies on being right on average.
• Qualitative ranking relies on the stock analyst being right.

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2. Ranking Systems Part 1
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3. Part 2