Let's start with a basic question. How do portfolio managers select stocks from a broad universe of more than a thousand companies?
Fundamental managers start with a basic company screen. For instance, they may first look for companies that satisfy conditions such as a price-to-earnings (P/E) ratio that is less than 15, earnings growth greater than 10%, and profit margins in excess of 20%. Filtering by those characteristics may result in, say, 200 potential candidates. Next, portfolio managers in consultation with their group of stock analysts spend the majority of their time thoroughly reviewing each of the potential candidates to arrive at the best 50 to 100 stocks for their portfolio. A quantitative manager, in contrast, spends the bulk of their time determining the characteristics for the initial stock screen, their stock selection model. They will look for five or more unique characteristics that are good at identifying the most attractive 200 stocks of the universe. A quantitative manager will then purchase all 200 stocks for their portfolio.
So let's expand on how these two investors—fundamental and quantitative—differ? Exhibit 1.2 details the main attributes of the following two approaches: