Case Study on Managing an Investment Portfolio

Students will form groups and will work on the following case. The overall grade is based on four factors 1) clarity of writing; 2) clarity of presentation; 3) depth of analysis; and 4) the investment decision process and recommendations.

Case study

As a recently hired CFA financial analyst for Horizon Investments you have been asked to make portfolio recommendation and setup an investment policy statement for three clients of the firm.

1) John Lambert has recently received his MBA and currently works for Oracle. He is 26 and recently married. He and his wife have saved nearly $100,000 for a down payment on a home. He contributes 10% of his salary to a 401K and Oracle provides a 10% match.   The investments are made in mutual funds run by Fidelity Investment. The 401K offered by Oracle has access to all of the funds offered by Fidelity. John Lambert needs to have a detailed investment plan set up for his 401K including the name of the funds and percentage of portfolio to be invested in the funds.

2) Elizabeth Yeo, aged 60, is managing director of USX and plans to retire in one year. Yeo will receive a lump sum severance payment of $500,000 from the company and plans to close out her company 401K which is entirely invested in USX stock where she has currently about 35,00 shares. Yeo is widowed and has a son who is married and who has a high-level position at an investment bank. Yeo maintains a money market fund currently value at $1.1 million and earns about 1.2% annually. She has a home, zero mortgage, currently valued at about $1 million and plans to continue living there. She also plans to begin to collect social security at the age of 62. Her living expenses, including maintaining the home, are about $80,000 a year. Her living expenses are expected to grow at an annual rate of 3 percent throughout her retirement period, which is expected to be 25 years given her family’s mortality history. You are requested to prepare an investment policy statement for Yeo and make some investment recommendations.   

3) Christopher Maclin, aged 40 is a supervisor at Barnett Co. and earns an annual salary of $100,000. Louise Maclin, aged 38, stays home to care for their newborn twins. She recently inherited $1.3 million (after taxes) in cash from her father’s estate. In addition, the Maclins have $20,000 in cash and $150,000 in Barnett common stock. They are unhappy about portfolio volatility and do not want to suffer a loss of more than 12% in one year. They recently purchased a new home. They need sufficient funds to fund their children’s college education and Christopher plans to retirement at age 65. Christopher is not very knowledgeable about finance but read that small cap and emerging market stocks provide the highest return over the long run. He plans to invest 50% of the inherited money in a small cap fund and the other in an emerging market fund. His wife is concerned about the decision. She requested Horizon review her husband’s decision and, if needed, provide an alternative investment strategy.

Estimating Stock Returns

Project Outline and Tasks:

Select two companies in two different industries and do the following:

Provide background information on the company and describe the industry in which the company operates in and its main products.

Determine key macroeconomic factors impacting each firm.

List and describe the major competitors to the selected company. Evaluate each firm using Porter’s 5 determinants of competition.

Compute and interpret the financial ratios described below for a five-year period. Look at the trend in the ratios to determine if they are deteriorating or improving and compare them against peers or the industry:

Current and quick ratios and net working capital

Inventory turnover, fixed assets turnover and total assets turnover

Debt ratio and TIE.

Gross profit margin and net profit margin and operating margin

ROE and ROA

Price/ Earnings and Market/Book

Du Pont Analysis

Find beta, R squared, alpha and the residual standard deviation for each firm using Excel. Interpret the results and recommend which firm should be added to a well diversified portfolio. Use 60 months of return data for the calculations.

Find the correlation between the two stocks and interpret.

Estimate the required return for each stock (SML).

Estimate the sustainable growth rate (g) for each stock. Find it for 3 years and take an average.

Estimate the 5 and 10-year historic growth rate in earnings. Compare to sustainable growth method.

Estimate the intrinsic value (price) of the two stocks using the 1) dividend discount model (DDM) approach and the 2) P/E multiplier approach. Make a buy or sell recommendation.

Evaluate stock using value criteria of dividend yield and price to book.

Use the Black-Scholes model to find the value of a call option and the value of a put option for each stock.