A little while ago in my previous entry I mentioned that I sit on the fence when it comes to Fundamental or Technical Analysis of stocks and couldn’t decide which way to go. But there is a part of Fundamental Analysis viz. Qualitative Analysis that appeals to me over its other part Quantitative Analysis.

Qualitative analysis makes me immune from my (un)founded fear of cooked up figures (if any) and the uneasy feeling of making decisions based purely on charts(Technical Analysis). There are several factors that must be taken into account like the business model, competitive advantage, management, corporate governance while making a comprehensive qualitative analysis.

While it is not possible to go into all of these factors in this forum, I would like you to give some thought to just one i.e. competitive advantage that any of your current and proposed investments enjoy. Why because, if a company enjoys immense competitive advantage, it can get away with a few dumb moves that it makes in the short term, learn from its mistakes, do some course corrections, survive in the long run and eventually subdue its competition. At least it will help you decide if should buy, hold or unload your stocks.

I would like to elaborate with a real life example that you are most likely familiar with and hence can see my point of view. I am sure all of you who are reading this blog have access to at least one (or several) notebooks or personal computers as otherwise you would not be reading this blog. And I think you are aware that there is a mass storage device ( hard disk drive) in your notebook or PC that stores all your applications and data.

There are several manufacturers who make these hard disk drives, out of these there is one company that I would like to quote as an example: Seagate Technology( Stock symbol US: STX) which is the biggest manufacturer of hard disk drives and nearly twice as big as its nearest rival. My recommendation of Seagate comes to you not as an investor but as a seller and as well as a consumer of Seagate Hard Drives.

As a seller of Seagate hard drives, only rarely do I see a hard drive fail under warranty. Even for such failure, I get excellent after sales service from Seagate and thus could keep my customers happy. I mean within a day or two of shipping the defective hard drive, I get an email confirmation from Seagate that they have received the hard drive and are working on it. And within a week I get a replacement to give it to my customer.

As a consumer I can vouch that none of the Seagate hard drives running in my three PCs has ever failed on me, four of them running as long as 5 years without any problems.

Given their quality, reliability and after sales service, I can infer that they have excellent procedures in place. But their operational effectiveness is not the same as the competitive advantage they enjoy. As this article clarifies

Operational Effectiveness means a company is better than rivals at similar activities while competitive advantage means by doing different activities or performing similar activities in different ways.

Discussing competitive advantage within the context of Seagate Technology, thanks to Michael E. Porter we have a model that defines the existence of Seagate in data storage industry.

1. Competition in the industry ( Seagate is a leader)
2. Potential of new entrants into industry ( See barriers to entry below)
3. Power of suppliers ( could not think of any)
4. Power of consumers ( Seagate is not at the mercy of any particular group of consumers as it enjoys a very wide consumer base )
5. Threat of substitute products ( There could be a real threat from Solid State Drives (SSDs) that are emerging in the data storage market with better features to offer. Though currently Seagate enjoys a price advantage vs. SSDs that it can offer to its consumers , Solid State Drives may eventually take over. Unless Seagate is taking to this new technology it is likely to loose its dominance)

Barriers to entry:

Before I wrap up, I would like you to see what barriers to entry (again there are many, but to name just a few) that Seagate enjoys

• High Startup costs ( To design, manufacture and distribute (worldwide) millions of hard disk drives with such complex technology entails high startup costs and hence a new entrant has to think twice before committing)
• Strong brand identity ( Though as a consumer if you buy a brand name PC you may not be aware of the hard drive inside it, the decision is made for you already. But if you buy a custom built PC or if you build a PC yourself you are more likely to specify a Seagate hard drive.)
• Strong customer loyalty ( Though Seagate HD is little bit more expensive, it has a market dominance)
• High switching costs ( This is where it enjoys a great advantage. Once a hard drive, Seagate or any other, is up and running, no one wants to replace it with another make, even if the latter comes free of cost. The hassle of installation, transfer of contents from one to another and the inevitable downtime this requires will not make it worthwhile)

Finally can you sleep peacefully if you have a suspicion that your hard drive may fail anytime taking all your valuable data with it?

I can’t.

Today’s news: gold surges past a record $900 an ounce. In today’s market, everything else with a tangible, marketable value has plunged: real estate, shares, currency, automobiles, computer products etc. The exception is oil which is rightly (?) termed as ‘black gold’. It is understandable that, so much of our life is dependent on oil that it appreciates, while all other assets with which we pay for it depreciate. They say a day may come when we may have to pay for black gold (oil) with gold. But why gold?

Is it because real gold can be minted into coins, and is convenient (?) to carry and exchange as a medium of currency? One can argue, because only so much of it is there, it will always retain its value or appreciate with increasing demand.

But it is hard to imagine that I will be handing over a bag of gold coins to fill up my gas tank. We are so used to the convenience of swiping a card at the cash counter, or typing in our credit card number while buying something off the Internet, that it is almost impossible to reverse the process.

When I was young I used to think what madness is this that we are so obsessed with possessing this ‘precious’ metal. It is after all a metal that we assign value to.

Sure enough it possesses superior chemical and electrical properties, which we could demonstrate time and time again in laboratories and real life applications, so can be assigned some utility value. But I could not see any reason for assigning a lofty economic(investment) value to it.

One may say because of its rarity. Because of its rarity if it appreciates too much in value, science and technology can always find some alternatives to its use or limits its use to a bare minimum.

I could hear someone saying reasons are historical and we follow the tradition. Even the early church could not shy away from stashing gold. Just look at what the Pope the Innocent IV said to Thomas Aquinas, “We cannot say as St. Peter of old, ‘Silver and gold have I none’ pointing to an abundant mass of treasure poured out in his presence.

They may argue with great vigor, “Why would God in his wisdom lavish all his disciples with gold and silver who profess greater faith in them than in Himself?” Can’t you see an apparent contradiction here?

My simple reason for not backing Gold is this: Gold is limited in supply while Life in all its form is abundant and is always for growth.

And I am for life.

Aquinas was wise in his reply to the pope, “Neither can you command, as did he (St. Peter), the lame man to arise and walk.”

“To be or not to be, that is the question;

Whether ’tis nobler in the mind to suffer

The slings and arrows of outrageous fortune,…..”

Hamlet ponders in William Shakespeare’s Hamlet, Prince of Denmark.

Well that may not be question that modern day Shakespeare would have had Hamlet to contemplate. He would rather have him philosophize on the merits of investing in stocks using either of the two approaches: Fundamental or Technical analysis of stocks in the investing public’s search for outrageous fortune.

I am sure Hamlet would be equally lost in this dilemma.

For one thing Hamlet was indecisive like many of us are and his uncertainty of knowledge is all the more applicable to most of us. To quote Peter Lynch in one of his books “Beating the Street”, “It is often what you know that can hurt you” or words to that effect. Such being the case, how can I discount what I don’t know?

Consider what he says on page 39 of this book , ” … we are confronted with the latest reasons that mankind is doomed; global warming, global cooling, the evil Soviet empire, the collapse of the evil Soviet empire, recession, inflation, illiteracy, the high cost of health care, fundamentalist Muslims, the budget deficit, the brain drain, tribal warfare, organized crime, disorganized crime, sex scandals, money scandals, sex and money scandals. Even the sports page can make you sick.”

Remember this book was published in 1993! and you can see many of the reasons still hold good today. Enough reasons for me to hold to my little cash.

For who can claim that they have 100% information on an investment proposal. The collapse of Long Term Capital Management in the not too distant past is still in memory. The Nobel laureate economists, physicists behind Long Term Capital claimed that they have figured out a rocket science formula for investment in bonds that is foolproof. Sure enough Long Term Capital gave phenomenal returns in the first three years of its foundation: 20 percent in 1994, 43 percent in 1995, and 41 percent in 1996! But its collapse in 1998 was even more dramatic: Long Term Capital’s equity stood at $4.1 billion on 1 August, $2.3 billion on 1 September, and $600 million by 21 September–90 percent of its equity was wiped out in just 55 days. (You may want to see this article for more information on this: Up like a rocket).

We don’t know how much more our venerable financial institutions will write down citing subprime market meltdown in the recent past.

When stalwarts stumble, it is no wonder novices like me may crumble. So I stand on the beach testing the waters; weighing endlessly the merits and demerits of Fundamental or Technical analysis of stocks.

May be one day I will take the plunge. Till that day arrives, I will deliberate like Hamlet, “Fundamental or Technical, that is the question”