Project on stocks
katoon
SemesterProject2019.docx
1
Overview
Background
The following document outlines a plan for investment for the target investor’s investment objectives, constraints, risk tolerances, strategy and execution. This document is to be used as a policy reference to attain the goals described above.
Purpose
The purpose of this mutual fund is to assist investors on the accumulation phase of their financial investing life cycle. The accumulation phase begins when investors begin their career and have the opportunity to invest their excess income into long term capital assets to be expended for retirement and their children’s education during the distribution phase. This significant time period allows the accumulation investor to consider the long-term growth period of their investment horizon (20-30 years), and how that implies the ability to take larger amounts of risk in the early stages of the accumulation period due to the nature of the business cycle.
1.Goals and Objectives
Risk Tolerance: With the adjusted close values of the S&P 500 as the basis, the market’s average standard deviation has been approximately 19.67% a year. A fundamental objective of this fund is to carry a higher risk, and as a result the fund will set a risk target level between 20-25% and a beta of approximately 1.03.
Return Objective: The fund will be taking more risk than the index, and consequently the fund will aim for approximately a 15% return. 5% higher than the S&P 500’s all-time historical average.
2. Constraints
Time Horizon: The designated time horizon of the fund is 3-5 years.
Liquidity: The fund’s holding period is relatively lengthy, requiring minimal cash reserves for the investor. A target cash reserves no greater than 10% is optimal depending on market conditions.
Regulations: The manager will be held to his fiduciary responsibility of acting within their client’s best interests, adherent to the “prudent investor rule”. The manager will also adhere to the Investment Company Act of 1940 which outlines the required elements of transparent information the fund must abide by, and outlawing insider trading. In addition, all traded securities are expected to be registered with the SEC in accordance with the Securities Act of 1933. Lastly, managers of the fund are expected to act in compliance with all state and federal regulatory measures and procedures that otherwise not explicitly listed.
Tax Considerations: To maximize total returns, the fund’s turnover rate will be kept to a minimum in order to reduce unnecessary capital gains taxes/liabilities and transaction fees. The fund manager is also responsible for providing monthly reports including cash flows, income, and monthly changes in value to avoid tax discrepancies and provide transparency for the investor.
3. Strategy
According to the risk tolerance of the fund, 70% will be allocated in stocks, 10% in a high yield bond fund, 10% in an ETF and lastly 10% in cash for investor withdraws and additional trades. There will be no asset allocation into options. The fund’s asset allocation captures low risk and high-risk securities from various sectors to minimize firm specific risk, and to achieve the target beta of approximately 1.03.
The strategy of the fund will be to adapt to the changing economic landscape and market conditions to maximize alpha and stay on target for the fund’s investment goals. When screening for stocks, stocks that are considered value stocks are recommended for this fund. Parameters to reference for the value stock qualification are a low price to earnings ratio, high inside ownership compared to their industry, and positive revenue growth ≥5 Years. Bonds held in the fund must be monitored to accommodate changes in the interest’s rates that would drastically affect their value. The purpose of holding bonds in this fund is to balance the beta and reduce potential losses in a poor performing market.
Execution:
I. Stock Selection
1) The market capitalization must be greater than $10 billion (Greater than or equal to “large” cap companies)
2) Must have positive Earnings Per Share Growth over the next 3-5 years.
3) Must have positive revenue growth in the previous 3 years.
II. ETF Selection
1) Minimum level of assets of $10 million.
2) Must have sufficient trade volume to be liquefiable in a short period.
3) Preferably a technology ETF due a lack of representation among stock assets.
III. Bond Selection
1) Must be A rated and above
2) Must have a 3-year average return greater than ≥5%
Benchmark: The benchmarks this fund will reference are the Power shares QQQ, Vanguard Total Stock Market ETF, SPY S&P 500 Trust ETF, and the DIA Dow Jones Industrial Average ETF. This collection of indices and ETFs correlate the portfolio composition of large and mega cap companies.
Evaluation: To effectively evaluate this fund at the end of the holding period, the fund’s return will be compared to the performance of the above listed benchmarks. Included in the presentation will be the reasoning behind the selection of securities, holding periods, and overall investment strategy.
Discussion: I began my process of evaluating stocks by deciding my portfolio’s sector composition. I wanted the portfolio to hold a slightly higher risk than the market’s return, however I selected securities from certain sectors such as pairs from consumer and defensive cyclicals and a high yield bond fund to hedge against a potentially bearish market. This gave the fund the characteristics to capitalize on upsides in the market with a small excess return, but also gave the fund the ability to minimize losses and potentially capture gains during downturns in the market to effectively reach alpha.
1) Southwest Airlines (LUV)
Beta: 1.81 Sector: Industrials
Southwest Airlines is a low-cost airline emerging as a leader in the industry. In 2018 they recorded a P/E ratio of 12.79 which is slightly above the industry average, however the company is forecasted to have a P/E ratio of 9.04 by 2021. Support for this forecast is their expected earnings growth at an average annual rate of 8.52%. Additionally, revenue has been growing steadily for the company in the past 3 years at around 3.7%, while their profit has grown 0.8%. In 2018 Southwest reached their highest free cash flow on record of 4.89 billion dollars. Southwest Airlines has a strong balance sheet, and relative to the stock price, it makes this stock a bargain. In the past 3 years, the average Free Cash Flow per Share Growth rate was 42.5% per year. Well above their competitors in the industry. With oil prices low and more Americans using airlines than ever before, Southwest Airlines has a large upside potential to keep hold and grow their market share. Especially when only, a few select airlines have such a large percentage of the United States market share.
2) Chipotle (CMG)
Beta: 1.31 Sector: Consumer Cyclical
Despite the norovirus and e-coli. scandals for the company that took years for the price to recover from, Chipotle is an emerging leader in the fast-food industry. The company’s business model of providing relatively healthy to-go burritos is popular with younger Americans, which I believe will continue to drive their price up. The company’s leadership is set on adapting to changes in market demand as well. This year they capitalized on their digital orders, which now account for 11% of their sales in 2018. Chipotle has some of the best growth statistics in their industry, they are anticipated to have an average earnings growth of 19.2% over the next 3 years and revenue growth of 8.7%. Additionally, Chipotle’s shares have soared 60% in value since the beginning of 2019, compared to the markets 13% return. Overall, despite the health scandals and the company’s abnormally high P/E ratio of 94.1, their balance sheet and company leadership suggest they will continue to rebound and garner market share.
3) SEI Institutional Investments High Yield Class A-Bond (SGYAX)
Beta: 0.18. Sector: High Yield Bond
While this bond fund is A rated, it has a concentration on lower quality bonds to provide higher yields. Which means in the event of a recession there is a chance for defaults and therefore drastically lowering the yield. However, in scenarios with small economic turbulence, the bond performs quite well in comparison to stocks. The composition of the bonds is roughly 72% corporate, 12% bank loans, 9% in asset backed, and 5% in cash. Since the start of 2019, the fund has returned 9.13%
4) Mondelez International (MDLZ)
Beta: 0.85. Sector: Consumer Defensive
Mondelez International is one of the world’s largest snack companies coming in at 9.87% market share, traded at a large market cap of 74.659 Billion. They hold the number 1 position in sales globally in biscuits, chocolate and candy, as well as the number 2 position in gum. Mondelez has a P/E ratio of 22.65 just above the industry average of 20.54. They also hold a lower debt-equity average at 0.49 compared to their industry’s 0.59. The notable statistic from Mondelez International is their year over year income growth. In the two past years they have had a 46.2% increase in net income. Mondelez also owns a large global snack selling brands such as Oreos, Ritz Crackers, Nabisco, and Chips Ahoy. Mondelez International has a strong global presence to back up these brands, where 22% of their sales come from Asia, 12% from Latin America and 39% in Europe. By 2030, E7 countries (China, India, Brazil, Mexico, Russia, Indonesia, Turkey) will overtake the G7 (Canada, France, Germany, Italy, Japan, UK, US) in size and purchasing power. In addition, 65% of the world’s middle class will be living in the Asia Pacific region by 2030. This gives Mondelez International a large opportunity to increase their market share in these emerging markets as these markets become more and more industrialized and consume larger quantities of packaged foods. The packaged foods industry registers a compound annual growth rate of 4.5% for the period 2015-2020, indicating these is room for growth.
