Portfolio management strategies and applications

Stock

Portfolio Management Project

Selected 10 companies

Company

Symbol

purchase date purchase price

Apple, Inc.

APPL

Industry/Sector: Technology/Personal Computer -- Investment Style: Large Growth

Brocade

BRCD

Communications Systems Inc.

Industry/Sector: Technology/Data Storage -- Investment Style: Small Growth

Joy Global Inc.

JOYG

Industry/Sector: Farm/Const/Mach -- Investment Style: Large Growth

Ctrip.com

CTRP

Industry/Sector: Consumer Services -- Investment Style: International

Gerdau SA

GGB

Industry/Sector: Steal & Iron -- Investment Style: International

Gol Linhas

GOL

Aereas Inteligentes SA

Industry/Sector: Regional Airline -- Investment Style: International

Green Mountain

GMCR

10/21/2009

Coffee Roasters Inc.

Industry/Sector: Processed Pkgd gds -- Investment Style: Small Growth

Rio Tinto PLC

RTP

10/21 / 2009

Industry/Sector: Steal & Iron -- Investment Style: International

Vale SA

VALE

10/21/09

26.90

Industry/Sector: Steal & Iron -- Investment Style: International

Wendys/Arbys

WEN

10/21/09

4.08

Group Inc.

Industry/Sector: Restaurants -- Investment Style: Small Growth

Introduction

Investing today is about taking advantage of growth from a broader international perspective. Every aspect of industry now functions in a global economic environment. Even a mom and pop shop that creates handmade baskets in Singapore can now sell their wares over the internet and compete with the likes of Sears and Wal-Mart. By approaching investing from the view that globalization creates new fixed and floating exchange rates, macroeconomic volatility and new roles for governments, investors can address important questions like which group of nations will come out of the current economic recession and then begin normalized growth. How will decisions made in the United States, the European Union and China affect economic volatility in smaller emerging nations and in what ways can investors take advantage of the new financial globalization?

This report offers insights into my portfolio that was built with the sole intention of taking advantage of global economic potential with a historic view. Consider for example, the steel industry will need to meet all new growth expectations from around the world as more emerging nations attempt to drop their current second and third world statuses. "We live in a world so rich that global income is more than $31 trillion a year. In this world, the average person in some countries earns more than $40,000 a year. But in this same world, 2.8 billion people -- more than half the people in developing countries -- live on less than $700 a year. Of these, 1.2 billion earn less than $1 a day." (Chossudovsky)

Brazil is an excellent example of a nation ready to move into the first world. They have a stable government, a young well educated population, unmatched natural resources and all new vast offshore oil reserves, the 2014 World Cup soccer tournament, 2016 Summer Olympics, and a tourism industry that can match both the United States and Europe. This country will need more steel in the next ten years than even China in order to meet the growing demand for modernizing their tourism industry for the Olympics, offshore oil rigs and ships to tap the oil reserves and a new roads and housing infrastructure to handle their new found wealth. Their auto industry is thriving thanks to their homemade ethanol reserves and they also are rich in resources such as gold, silver, iron ore, beef, pork, sugar, ethanol, fruits and vegetables and now they have more potential oil than the Middle East. As businesses continue to expand and become multi-national conglomerates, they have a responsibility to not only help their home markets but to any and all areas that they happen to migrate in to. The nations that become the new homes for these organizations also undergo a transition that converts them into stakeholders of the companies. "Recognizing the moral claims by stakeholders other than the shareholders introduces other values than financial value in the spectrum of what needs to be pursued by the organization. Stakeholder management is not merely instrumental to create shareholder value, but normative." (Windsor, 1999)

These are all powerful motivators to incorporate a piece of that growth potential into a portfolio. Applying the intricacies of international finance into a personal portfolio only makes sense as debt hinders growth in the United States and China has nowhere to sell its plethora of exports. So other avenues like Brazil should be taken into consideration.

Class & Industry

Economic indicators such as unemployment and consumer spending will not play a major role in this portfolio because the object is to incorporate international growth into the picture. The indicators needed for this type of portfolio will follow reports from organizations like the United Nations and the World Bank. It is true that growth in the United States may be slow until mid-2010, but Brazil is growing now and has even great potential for double digit growth over the next ten years. This portfolio is taking into consideration world demand for steel. Cutting costs and postponing expenditures are popular ways to make short-term profits grow in the United States and may add investor values. But, to make global finance and globalization work, it seems like a better idea to hold true that organizations must find a perfect mix between long-term goals and objectives and the short-term maximization strategies of their global corporate management. The world continues to become smaller as new technologies like the Internet and the business communities face all new challenges from the highly competitive global economy. Over the last few decades, few industries represent better approaches in ways to incorporate globalization better than the steel industry.

The economic downturn has dramatically slowed this industry but global demand is expected to rise sharply in 2010. The portfolio carries three very strong steel players, Vale, Rio Tinto and Gerdau. All three are large well established and well managed international organizations and all three are dominating forces in the steel industry for Australia, Brazil the African continent and China; all areas with very high expectations of growth. Also in this group is Joy Global, an American company but their reach is definitely global when it comes to their machinery which is used in the agricultural and manufacturing arena.

Also in line with the international approach is Gol which is a regional airline in Brazil that will get a boost in passenger and cargo miles from the growth in Brazil, especially from the World Cup and the Olympics. Travel is the background of CTRP.com. This company has been growing exponentially as travel both in and around china continues to rise. The company was built on the principles of a Priceline.com which recently shot over 200, CTRP may do the same. The portfolio adds in a few tech plays. Apple has recently entered China with their iPhone and IPods and they are nowhere near saturating their markets. Brocade is in the process of trying to sell themselves to a bigger partner to drop their debt load so this is a speculative purchase as vendors like HP and IBM go searching for data supplies and the weak dollar make international giants take notice. Wendy's is also in this portfolio because it is selling at over 100% less than its intrinsic value which makes it an excellent take over player. The company will provide a modest dividend until the stock is acquired or maybe the economic recovery can help the company boost sales.

The portfolio closes with a company that may grow really fast from small cap to large cap as they increase sales. Green Mountain Coffee Roasters have been building new distribution centers for their ingenious K-cup coffees for the single cup coffee lover. They have recently made a deal with Kmart and William Sonoma so they will be reaching all areas of their potential customer base.

Markowitz & Risk

Investors face the dilemma of taking an amount of money today or investing it in some other project or financial vehicle like stocks or bonds with the intention of receiving additional funds at some future date. It is important to be able to understand the current and the future value of money. The idea is based on the question; does a dollar today have the same value as a dollar one year from now? The bill is physically the same but money now can do more over time because of the fact that there is interest and compounding. A simple example can provide insight. If an investor has $10,000 to invest (Option A) over the course of the next three years or he could keep the money in reserves (Option B).

In this example, if the investor chose option A with an expected annual rate of return of four and half percent, the future value of the investment after one year would equal $10,450 which would be calculated by multiplying the principal amount by the interest rate and then adding the amount to the principal:

First Year Return = $10,000 x (0.045 + 1) = $10,450

Second Year Return = $10,450 x (0.045 + 1) = $10,920.25

Third Year Return = $10,920.25 x (0.045 + 1) = $11,411.66

In other words, the future value of money would have the simple formula:

In this example, if the investor chose option B, the present value this year would still be $10,000. But, if the $10,000 was kept in reserves and then invested one year later, the present value of the $10,000 would be different. The present value of the $10,000 in the future would need to be calculated. Calculating present value forces investors to first subtract the accumulated interest. In other words, a future payment amount must be discounted by the current interest rate or the previous calculation can be rewritten to replace the P. variable with present value (PV):

If and when the investor chooses not to invest in an interest bearing investment, choosing option B, they are deciding to invest in an investment that does not pay, in this example, four and half percent.

First Year Return = $10,000 x (0.045 + 1)-1 = $9,569.38

Second Year Return = $10,000 x (0.045 + 1)-2 = $9,157.30

Third Year Return = $10,000 x (0.045 + 1)-3 = $8,762.97

The old saying that time is money can actually be demonstrated in this example. The value of money for investors is not the same today as it would be at some point in the future as can be seen in the example:

Option A

Option B

Year 1

$10,450

$9,569.38

Year 2

$10,920.25

$9,157.30

Year3

$11,411.66

$8,762.97

Markowitz was very influential in the underlying concepts that helped create the Capital Asset Pricing Model or CAPM. CAPM takes into consideration the risk associated with any investment in addition to the rates of return and allows investors to compare those factors to a source like the overall stock market, individual index within the stock market or a combination of investments. Investors' goals are to minimize risk and CAPM is the tool that helps them accomplish that objective.

To understand the Capital Asset Pricing Model one must grasp the concept of a Beta. Beta is the overall risk in investing in a large market such as the New York Stock Exchange and can be defined as representing the number one (1.0000). Every organization on the New York Stock Exchange, NASDAQ or the American Stock Exchange has a Beta for each company. A company's Beta can be looked up on Yahoo Finance for example and has been provided for the 10 stocks in this portfolio. A company's Beta is basically a calculated risk factor to show how much risk an investment in a particular company would be when compared to other companies or the market itself. If a company sports a Beta of 2.6, it is reasonable to assume that the company is 2.6 times riskier than the overall market. A formula to utilize the Beta to acquire a required rate of return is:

Ks = Krf + B x (Km -- Krf) where

Ks = The Rate of Return

Krf = The Risk Free Rate

B = Beta

Km = The expected return on the overall stock market

This formula is a standard to successful investors and the assumption of figuring a risk free rate is usually a comparison to less risky items such as treasuries. An example of the rate of return using CAPM would look like this:

If an investor assumes a risk free rate of 5% and an overall stock market return of 12.5%, Apple has a Beta of 1.5, one need merely plug in the figures to see if an investment were worthwhile. In other words, the rate of return one expects for investing in Apple should be higher than the market rate of 12.5%. In this example, Apple should produce at least a greater than seventeen percent return which may or may not be possible.

Ks = Krf + B x (Km -- Krf)

16.25% = 5% + 1.5 x (12.5% - 5%)

Apple beta = 1.5

This portfolio is consistent with risk aversion because it is heavy in steel and the international markets. The three steel plays adjust their styles of management to better meet the social needs of their stakeholder nations. Stakeholder management serves as a mix of social and financial responsibility that can meet the socially responsible expectations. The steel and mining industries have all made great strides to be better neighbors through social responsibility exhibitions. "Although most companies are concerned with sustaining profitability over the long-term and would be happy to allow NGOs to emerge from the impetus inherent within a free market, players in the steel industry have especially strong reason to develop strategies that consider the sustainability of their activities. The most fundamental reason is perhaps that, without principles to sustain a physical environment in which the company may operate, it becomes impossible to make a profit." (IMF)

Portfolio Efficient Frontier

Portfolio Risk/Return Scatter Chart

The world is geared for an economic recovery and the markets will benefit greatly from the new growth, but on a global level. The main idea behind the MPT is that the overall stock market is hard to beat but those who beat the market are those that take above-average risks. The above average risk is bet on a second world nation that has had political problems and inflation issues in the recent past. My risks are on emerging Brazil and also on a weak dollar promoting international corporate takeovers. This risk factor is high enough so as not to need derivatives for example and bonds are not safe in an economic downturn as corporations have more and more trouble paying their long-term debt.

A dividend support base is also in place so that if the market hits a downturn the expected dividend income will carry the portfolio until a new recovery can occur. My portfolio is very risky in the sense that Brazil could botch the potential growth, but the portfolio should prevail with CTRP and GMCR each having large upside potential. I think I will be able to take advantage and incorporate the Markowitz theory, except all within the stock arena. MPT has shortcomings in the real world and adding perceived risky investment such as futures will not be necessary in order to reduce the overall portfolio risk. This portfolio does follow MPT ion the assumption that the individual stocks' performance will be independent of other investments in the portfolio. History shows, there are no such instruments that are 100% risk free. Government-backed bonds are presumed to be risk free, but, in reality, the United States and England are both in the process of losing their AAA standing as debt looms large during the economic downturn. Long-term debt will also put a great deal of pressure on future generations Treasury Bonds need to be paid for. Higher inflation and interest rate changes will affect their value.

Returns

Current returns are going well -- but this portfolio is built to grow over time and has a very low risk factor based on betas of the companies in the portfolio. Opportunities are abundant so every buy decision will be geared to take advantage of long-term opportunities. "Whenever a market falls in value, you should become more enthusiastic, not less so. Individual stocks and bonds may lose all value. But it is rare that entire markets disappear. (Clements)

If the risk factor were higher, I would incorporate some risk-free assets such as either low risk corporate bonds or local municipal bonds. The goal would be to only invest in municipal bonds with AAA ratings because of the tax advantages. A tax-exempt investment can be considered as very attractive. In addition, I would add only general obligation municipal bonds as opposed to revenue bonds because they are less risky. So if my portfolio carried more risk, the mix I would use would be a 70% Equity and 30% Bond mix allowing for growth and safety. I would stagger maturity dates to minimize risk of interest rate movement. But, because my risk tolerance is higher because of my long-term objectives, this strategy of incorporating bonds would only be necessary if my portfolio risk factors rose. These are the expected bond returns for the general obligation municipal bonds:

Maturity

Current Yield

2 years

0.89%

5 years

1.72%

7 years

2.33%

10 years

3.20%

15 years

3.97%

20 years

4.41%

30 years

4.65%

Basic financial theories point out that long-term investments require a higher rate of return than do short-term financial instruments. An excellent example of this can be observed by comparing short-term Treasury bills with longer-term Treasury notes. Both are assumed to have the identical investment risk based on a federal government guarantee, but longer-term notes are affected by the time value of money for longer periods of time. So investors are exposed to long-term fluctuations in interest rates which actually imply greater risk. The longer the time interval requires a higher rate of return to compensate for the long risk burden. That is why stocks will be my sole investment.

To build a good portfolio, I will follow certain personal rules that will help me stay the course. I avoid tips from others and do my own research. I feel small investors are better off using market orders and as long-term investor, the odds of beating the market rise. My portfolio is geared to excel after 2010 but the purchases are in place today. The point remains, I don't worry about the small stuff when investing for the long-term and a low P/E ratio doesn't necessarily mean that a security is undervalued. As a matter of fact, a low P/E could mean that the company's earnings were flat or are in the process of slowing. If the P/E Ratio is useful to compare two companies in the same industry then that is a good use for the ratio. Oh and last but not least -- Avoid bubbles! So the approach to follow is to create a sound long-term growth plan:

Read the Wall Street Journal on a Daily basis

Use Stop Loss every time - Cut your losers at 8%

Avoid investment tips

Don't use mutual funds

Buy using Market Orders

Look for good companies with sustained growth

Never wait for the market to correct

Timing the market is impossible

Take advantage of 401k's

Price does count

Survey

9-14 points Conservative investor

15-21 points Moderate investor

22-27 points Aggressive investor

Finding out how friends and peers feel about risk, I conducted an informal survey about their feelings about risk tolerance. I asked eight friends and eight acquaintances seven detailed questions about risk. Out of the sixteen people, six scored between 9 and 14 points in my survey which demonstrates a very conservative investment view, and of those six, five were 45 years old or older. Four scored between 15 and 21 which demonstrated moderate investment views and three were 45 years old or older. The remaining survey takers were between the ages of 18 to 25 and they all scored between 22 and 27 so they had very aggressive investment views. Because my portfolio is moderately risky, my portfolio would be appropriate for the people who scored between 15 and 21. The moderate investors in this case might be very pleasantly surprised if my forecasts are correct over the next 10 years.

SURVEY

What's Your Risk Tolerance?

1. Just 60 days after you put money into an investment, its price falls 20%. Assuming none of the fundamentals have changed, what would you do?

a. Sell to avoid further worry and try something else.

b. Do nothing and wait for the investment to come back.

c. Buy more. It was a good investment before; now it's cheap investment, too.

2. Now look at the previous question another way. Your investment fell 20%, but it's part of a portfolio being used to meet investment goals with three different time horizons.

2A. What would you do if the goal were five years away?

a. Sell

b. Do nothing

c. But more

2B. What would you do if the goal were 15 years away?

a. Sell

b. Do nothing

c. But more

2C. What would you do if the goal were 30 years away?

a. Sell

b. Do nothing

c. But more

3. The price of your retirement investment jumps 25% a month after you buy it. Again, the fundamentals haven't changed. After you finish gloating, what do you do?

a. Sell it and lock in your gains

b. Stay put and hope for more gain

c. Buy more: It could go higher

4. You're investing for retirement, which is 15 years away. Which would you rather do?

a. Invest in a money-market fund or guaranteed investment contract, giving up the possibility of major gains, but virtually assuring the safety of your principal.

b. Invest in a 50-50 mix of bond funds and stock funds, in hopes of getting some growth, but also giving yourself some protection in the form of steady income.

c. Invest in aggressive growth mutual funds whose value will probably fluctuate significantly during the year, but have the potential for impressive gains over five or 10 years.

5. You just won a big prize! But which one? It's up to you.

a. $2,000 in cash

b. A 50% chance to win $5,000

c. A 20% chance to win $15,000

6. A good investment opportunity just came along. But you have to borrow money to get in. Would you take out a loan?

a. Definitely not

b. Perhaps

c. Yes

7. Your company is selling stock to its employees. In three years, management plans to take the company public. Until then, you won't be able to sell your shares and you will get no dividends. But your investment could multiply as much as 10 times when the company goes public. How much money would you invest?

a. None

b. Two months' salary

c. Four months' salary

SCORING YOUR RISK TOLERANCE

To score the quiz, add up the number of answers you gave in each category a-c, then multiply as shown to find your score:

(a) answers ____ X 1 = ____ points

(b) answers ____ X 2 = ____ points

(c) answers ____ X 3 = ____ points

YOUR SCORE ____ points

If you scored… you may be a:

9-14 points Conservative investor

15-21 points Moderate investor

22-27 points Aggressive investor

Apple, Inc. Nasdaq APPL

Apple Inc., together with subsidiaries, designs, manufactures, and markets personal computers, mobile communication devices, and portable digital music and video players, as well as sells various related software, services, peripherals, and networking solutions. The company sells its products worldwide through its online stores, retail stores, direct sales force, third-party wholesalers, resellers, and value-added resellers. In addition, it sells various third-party Macintosh, iPhone, and iPod compatible products, including application software, printers, storage devices, speakers, headphones, and various other accessories and peripherals through its online and retail stores, and digital content and applications through the iTunes Store. The company sells its products to consumer, small and mid-sized business, education, enterprise, government, and creative customers. As of September 26, 2009, it had 273 retail stores, including 217 stores in the United States and 56 stores internationally. The company, formerly known as Apple Computer, Inc., was founded in 1976 and is headquartered in Cupertino, California. (Yahoo Finance)

Industry: Personal Computers

AAPL SECTOR / INDUSTRY MEMBERSHIP

Sector:

Technology

Industry:

Personal Computers

INTRADAY PERFORMANCE SUMMARY

Ticker

Change

Apple Inc.

AAPL

0.29%

Personal Computers

1.69%

(Yahoo Finance)

KEY EXECUTIVES

Pay

Exercised

Mr. Steven P. Jobs, 53

Co-Founder, Chief Exec. Officer $0

Mr. Peter Oppenheimer, 46

Chief Financial Officer and Sr. VP

$1.20M

Mr. Timothy D. Cook, 48

Chief Operating Officer

$1.42M

Mr. Robert Mansfield, 48

Sr. VP of Mac Hardware Engineering

$898.00K

$13.56M

Mr. Sina Tamaddon, 52

Sr. VP of Applications

N/A

N/A

Dollar amounts are as of 31-Dec-08 and compensation values are for the last fiscal year ending on that date. "Pay" is salary, bonuses, etc. "Exercised" is the value of options exercised during the fiscal year.

Market Cap (intraday)5:

Enterprise Value (21-Nov-09)3:

Trailing P/E (ttm, intraday):

31.79

Forward P/E (fye 26-Sep-11) 1:

21.25

PEG Ratio (5 yr expected):

1.43

Price/Sales (ttm):

4.94

Price/Book (mrq):

6.48

Enterprise Value/Revenue (ttm)3:

4.29

Enterprise Value/EBITDA (ttm)3:

18.786

Fiscal Year

Fiscal Year Ends:

26-Sep

Most Recent Quarter (mrq):

26-Sep-09

Profitability

Profit Margin (ttm):

15.61%

Operating Margin (ttm):

20.96%

Management Effectiveness

Return on Assets (ttm):

10.25%

Return on Equity (ttm):

23.35%

Income Statement

Revenue (ttm):

36.54B

Revenue Per Share (ttm):

40.914

Qtrly Revenue Growth (yoy):

25.00%

Gross Profit (ttm):

13.14B

EBITDA (ttm):

8.34B

Net Income Avl to Common (ttm):

5.70B

Diluted EPS (ttm):

6.29

Qtrly Earnings Growth (yoy):

46.60%

Balance Sheet

Total Cash (mrq):

23.46B

Total Cash Per Share (mrq):

26.051

Total Debt (mrq):

0

Total Debt/Equity (mrq):

N/A

Current Ratio (mrq):

1.881

Book Value Per Share (mrq):

30.931

Cash Flow Statement

Operating Cash Flow (ttm):

10.16B

Levered Free Cash Flow (ttm):

6.87B

(Yahoo Finance)

Stock Price History

Beta:

1.5

52-Week Change3:

S&P500 52-Week Change3:

36.42%

52-Week High (21-Oct-09)3:

52-Week Low (20-Jan-09)3:

78.20

50-Day Moving Average3:

200-Day Moving Average3:

Share Statistics

Average Volume (3-month) 3:

17,644,600

Average Volume (10 day) 3:

14,909,000

Shares Outstanding5:

Float:

% Held by Insiders1:

0.67%

% Held by Institutions1:

71.50%

Shares Short (as of 30-Oct-09)3:

15.17M

Short Ratio (as of 30-Oct-09)3:

0.7

Short % of Float (as of 30-Oct-09)3:

1.70%

Shares Short (prior month) 3:

15.84M

Dividends & Splits

Forward Annual Dividend Rate4:

N/A

Forward Annual Dividend Yield4:

N/A

Trailing Annual Dividend Rate3:

N/A

Trailing Annual Dividend Yield3:

NaN%

5-Year Average Dividend Yield4:

N/A

Payout Ratio4:

N/A

Dividend Date3:

N/A

Ex-Dividend Date4:

20-Feb-96

Last Split Factor (new per old) 2:

2:1

Last Split Date3:

28-Feb-05

(Yahoo Finance)

DIRECT COMPETITOR COMPARISON

AAPL

DELL

HPQ

MSFT

Industry

Market Cap:

27.95B

31.04B

Employ-ees:

34,300

76,500

321,000

93,000

34.30K

Qtrly Rev Growth (yoy):

25.00%

-22.30%

-2.10%

-14.20%

6.50%

Revenue (ttm):

36.54B

53.70B

56.30B

36.54B

Gross Margin (ttm):

35.96%

18.38%

23.21%

78.42%

18.38%

EBITDA (ttm):

8.34B

3.73B

15.44B

21.81B

3.73B

Oper Margins (ttm):

20.96%

5.47%

9.22%

34.57%

5.83%

Net Income (ttm):

5.70B

1.84B

7.32B

13.77B

N/A

EPS (ttm):

6.289

0.941

2.970

1.539

0.94

P/E (ttm):

31.79

15.19

16.85

19.25

31.88

PEG (5 yr expected):

1.43

1.12

1.23

1.45

1.43

P/S (ttm):

4.94

0.58

1.01

4.70

3.79

DELL = Dell Inc.

HPQ = Hewlett-Packard Company

MSFT = Microsoft Corporation

Industry = Personal Computers

(Yahoo Finance)

COMPUTER HARDWARE (U.S.) RANKED BY SALES

Company

Symbol

Price

Change

Market Cap

P/E

International Business Machines Corp.

IBM

-0.45%

13.03

Hewlett-Packard Company

HPQ

50.04

0.44%

16.85

Dell Inc.

DELL

14.29

-9.96%

27.95B

15.19

Cisco Systems, Inc.

CSCO

23.46

-0.93%

23.91

Xerox Corp.

XRX

7.83

0.64%

6.81B

22.37

Sun Microsystems Inc.

JAVA

8.61

0.12%

6.49B

N/A

Seagate Technology

STX

15.59

-2.87%

7.76B

N/A

Apple Inc.

AAPL

-0.29%

31.79

NCR Corp.

NCR

10.11

1.20%

1.61B

20.47

EMC Corporation

EMC

17.04

-0.76%

34.76B

33.61

COMPUTER HARDWARE (NON-U.S.) RANKED BY SALES

Company

Symbol

Price

Change

Market Cap

P/E

TOSBF.PK

5.10

1.80%

N/A

N/A