1) Portfolio Management is all about an investors’ SWOT, their Strengths, Weaknesses, Opportunities and Threats. A portfolio on the other hand is a combined collection of investments that is held by an investment company, an individual or a financial institution. Spradlin (1999) Suggests that, efficient portfolio management is paramount to adding shareholder value in any organization. However, the art of portfolio management stretches beyond evaluation techniques. More significantly, it is the ability to promote actionable steps utilizing all company assets that allows managers to create shareholder wealth. In my study I decided to construct a portfolio of two stocks from two major companies, Estee Lauder Company Inc and Walmart stores Inc. Estee company deals with skin care, make-up, fragrance and hair care products, while on the other hand Walmart is an American multinational corporation that runs the chains of large discount stores and warehouse stores. The two companies are negatively co-related and hence the portfolio will be diversified implying that unsystematic risk will be reduced and hence a positive portfolio performance.

1)Covariance of Returns.

The covariance of returns measures how two assets relate with one another, if the Covariance is positive then it implies the assets move in the same direction, if the covariance is negative the assets move in the opposite direction. The Covariance helps the investor to know how the stocks move together and whether their relationship is strong.

Estee Company Inc has a Covariance of 8.8713814 on the other hand Walmart Company Inc has a covariance of3.98539. The covariance of both companies is positive, implying that they both move in the same direction.

Therefore Estee and Walmart, two companies have positive covariance of returns and hence move in one direction.

2)Correlation of Each Asset.

The Correlation of an asset is a technique that enables an investor to understand how strongly or weakly pairs of variables are related.Spurgin (2001) notes that, one of the difficult problems in asset allocation is accounting for changes in the correlation between assets and asset classes. This problem is particularly evident among hedge funds, where many strategies those appear uncorrelated with the stock market for long periods of time suddenly become highly correlated with the market during periods of substantial market decline. The standard market-model for securities assumes constant correlation. Estee Leuder Company has a Correlation of0.979999 While Walmart on the other hand has a Correlation of 0.981650.The implication of the above is that there is indeed a negative correlation. This is because both Correlations are showing values less than 1, this indicates a perfect negative correlation. The two assets therefore move together in a linear manner but in opposite directions.

3)BETA

The Beta Coefficients as indicated on the Companies’ profile is Estee Lauder has a Beta of 0.99. While on the other hand Walmart has a Beta Coefficient of 0.4. A Beta coefficient below 1 suggests below average Risk and Return and hence in the above portfolio Risk and Return are below average. Markowitz (1978) suggested that estimating the beta systematic risk coefficient for market assets, finance professors, stock brokers, investment managers, and others began expending large quantities of resources each year on estimating betas. Betas are important because they are used to measure the risk of an investment that cannot be diversifies away. Therefore Beta does not measure risk in a standalone basis but the risk that an investment adds to an already diversified portfolio.

 

 

5) Historic Prices,

According to Yahoo! Finance, the Historic figures stand as follows;

Estee Company Inc;

Adjusted Closing Prices as at 26/3/2014 stand at $67.23

Adjusted Closing Price as at 18/3/2013 stood at $61.76

Walmart Company Inc;

Adjusted Closing Prices as at 26//2014 stand at $76.23

Adjusted Closing price as at 25/3/2013 stood at $ 73.06

The closing price is the most recent up-to date valuation of a security until the trading begins again the following day. The closing prices provide a marker for investors to be able to compare previous closing prices with recent closing prices. In both companies the closing prices in March of the same year, 2013 was slightly lower than the closing price in March of 2014.

6) The Time period, the time period in both companies is given Daily from March 2013 to March 2014.This is a maximum of 12 months.

7)Variance.

Bird (1986) explains that when risk is modeled by the       portfolio’s variance the modeling process becomes much simpler and is computationally more efficient. The variance measures how far a set of numbers or a range of numbers is spread out. A variance of 0 indicates that all the values are the same or identical, while a variance that is small indicates that the data points are very close to the mean or the expected return. Variance values that are high indicate the data points are away from each other. There are various methods used to calculate the Variance, Goodman (1960),explained that a simple exact formula for the variance of the product of two random variables, say, x and y, is given as a function of the means and central product-moments of x and y. The usual approximate variance formula for xy is compared with this exact formula.

Estee Lauder Company has a Variance of 9.1426692 while Walmart Company INC has a variance of 4.532920.This Implies that the variance values of Estee Lauder are higher and hence the data values are away from each other, this is compared to Walmarts’ low variance whose implication is that the data points are close to each other.

8) Standard Deviation

The standard deviation is calculated as the square root of the     variance and hence Estee Lauder Company has a Standard Deviation of 3.0236847while Walmart has a standard deviation of           .The implication of this is that 2.129065.Bland (1996) noted that the standard deviation of repeated measurements on the same subject enables us to measure the size of the measurement error. We shall assume that this standard deviation is the same for all subjects, as otherwise there would be no point in estimating it. The main exception is when the measurement error depends on the size of the measurement, usually with measurements becoming more variable as the magnitude of the measurement increases. Estee Lauder has a higher Standard Deviation as compared to Walmart hence it’s the riskier asset and therefore its returns are generally higher.

9)Summation of Each of the Stock.

Estee Lauder Company INC has a summation of total Volume of 460,135,900, While Walmart has a summation that is equal to 1687,187,700.

10) Expected Rates of Return of each stock

The Expected Rate of Return of Estee Laude Company inc or the Average is given by 1776586.486. The Expected Rate of Return of Walmart Company Inc is given by6642471.26

11) Expected Rate of Return of the whole portfolio.

The expected rate of return of the whole portfolio is 8,479,057,746,this value is based on the volume of both assets. A weight of 50% 50% is normally used when the percentage is not specified as is the case above.

12) Risk Premium.

Scott (2004) explains that themethod for estimating the market risk premium that accounts for shifts in investment opportunities by explicitly modeling the underlying process governing the level of market volatility. The risk premium is measured as E®-Risk free rate. Most investors base their assumption on the U.S treasury bonds as the benchmark of the Risk Free Rate; this is mainly taken to be 2%. Its given as the difference between the Expected Rate of Return for the Company and the Risk free Rate. Estee Company INC has a Risk Premium that is equal to (1.10%-2%)=-0.9% while Walmart has a Risk premium equal to (2.5%-2%)=0.5%

2) Valuation of the Two stocks.

The Constant Growth Model

Morris (2006) explained that the constant growth model is very sensitive to the assumptions regarding the firm’s operating ratios, capital structure, and dividend policy. If the constant growth model is used and these factors are not coordinated and consistent, the valuation estimate using the equity method will not agree with the valuation estimate obtained with the invested capital method.

It is calculated as P=(D*(1+g))

r-g

ESTEE;                      WALMART;

28.32=(0.8*(1+G)         1787.50=(1.92*(1+G)

1.10%-G                                                      2.5%-G

=1.04%                               =2.50%

From the above it is evident that Walmart has a higher growth rate of 2.5% as compared to Estees’ 1.04%. Walmart also has a higher dividend as compared to Estee.

3) FINANCIAL ANALYSIS

Altman (1968) suggested that the detection of companyoperating and financial difficulties is a subject which has been particularly susceptible to financial ratio analysis.Financial ratio analysis are widely used to compare the performance of the company with another company and decide on the methods and steps to take incase the variation between companies is too wide or too narrow.

1) Liquidity Ratios.

Liquidity Ratios measure the ability of a company to meet its short term financial obligations, the higher the ratio the better the firm is in a position to meet its short term commitments.

Current Ratio=Current Assets

Current Liabilities

Estee Lauder (2014) = 1.9119:1

Walmart (2014)= 0.882327:1

Quick Acid Test Ratio= Current Assets- Inventory

Current Liabilities

Estee Lauder (2014)=3.11487

Walmart inc (2014)=61184999

Moss (1993) explained that many businesses are faced with liquidity problems for various reasons. This is especially true for small businesses, since most must operate with fewer sources of both short and long term financing than larger firms.

Where less financing is available, more assets must be held in liquid form to meet daily transactions and emergency requirements. Larger firms, that have better access to both the money and capital markets, can afford to hold fewer current assets and meet cash requirements just as quickly and efficiently through borrowing

CashRatio=Cash

Current liabilities

Estel Lauder Company=337.93

Walmart Company=105.00

The mplication of the above is that Estel has a higher cash Ratio as compared to Walmart company and hence its able to meet its short term obligations faster.

2) Profitabilty Ratios,

They evaluate the firms abilities to generate earnings.

Gross Profit Margin= Gross profit *100%

Net Sales

Estee Lauder (2014)= 80%

Walmart Inc (2014)=24%

Net Profit Margin= Net Income*100%

Net Sales

Estee Lauder (2014)=1.247

Walmart (2014)= 4.028

Operating Proft= EBIT*100%

Net Sales

Estee Lauder (2014)=23.28%

Walmart (2014)=22.83%

Return On Equity= Net Income*100%

Shareholders Equity

Estee Lauder (2014)=14.23%

Walmart (2014)=62.4%

Return on Assets=Net Income

Total Assets

Estee Lauder (2014)=1.3014

Walmart Company (2014)=0.07825

Estee Lauder has a higher Return on Assets as compared to Walmart/

 

3) Activity Ratios.

Companies use this ratios to turn their production into cash or sales as fast as possible.

Inventort Turover=Cost of Goods Sold

Inventory

Estee Lauder (2014)=1.819

Walmart company(2014)=1.294

 

Days Sales in inventory=365

Inventory Turnover

Estee Lauder (2014)=193.122

Walmart Company (2014)=282.071

 

Average Inventory= Beginning Inventory+Closing Inventory

2

Estee Laude (2014)=0.55

Walmart Company (2014)= 22429000

Collection Period= Average Inventory

365 days

 

Estee Laude (2014)=0.001507

Walmart company (2014)=61449.32

4) Whether The Portfolio is overvalued or Under valued

E®= Rf+B(Rm-Rf)

Where Rf is the risk free rate taken to be 2%, Rm is the return in the market portfolio and B is the Beta coefficient.

=2%+0.99(1.10-2%)

=1.109

Undervalued, its higher than the investors required return

5) Whether to Invest or Not.

They have a positive covariance of returns, they are negatively correlated and hence portfolio will be diversified and the returns will be high, the risk will be low. I would invest in the portfolio.

work cited

Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The journal of finance, 23(4), 589-609.

Bird, R., & Tippett, M. (1986). Note—Naive Diversification and Portfolio Risk—A Note. Management Science, 32(2), 244-251.

Bland, J. M., & Altman, D. G. (1996). Statistics notes: measurement error. Bmj, 312(7047), 1654.

Fabozzi, F. J., & Francis, J. C. (1978). Beta as a random coefficient. Journal of Financial and Quantitative Analysis, 13(1), 101-116.

Goodman, L. A. (1960). On the exact variance of products. Journal of the American Statistical Association, 55(292), 708-713.

Morris, J. R. (2006). Growth in the Constant Growth Model. Business Valuation Review, 25(4), 153-162.

Moss, J. D., & Stine, B. (1993). Cash conversion cycle and firm size: a study of retail firms. Managerial Finance, 19(8), 25-34.

Scott Mayfield, E. (2004). Estimating the market risk premium. Journal of Financial Economics, 73(3), 465-496.

Spradlin, C. T., & Kutoloski, D. M. (1999). Action-oriented portfolio management. Research-Technology Management, 42(2), 26-32.

Spurgin, R., Martin, G., & Schneeweis, T. (2001). A method of estimating changes in correlation between assets and its application to hedge fund investment. Journal of Asset Management, 1(3), 217-230