Analysis and answer which portfolio has the best performance compared to the others?

Executive Summary:

This project analyzes the performance of 10 individual stocks and the performance of 3 portfolios. It focuses on the basic concepts of Average Return, Std. Deviation, Variance and Regression which is compared to the S&P 500. The major purpose of this is to figure out how each individual stock performs against the S&P 500 and which portfolio has high risk and better return.

Table 1:

Analysis Overview of Table 1:

In the analysis that we performed for Table 1, we found a couple of returns and tried to understand how each of the 10 companies performed individually and compared to S&P 500. By finding out the average returns, variances, beta, alpha and regression analysis, we were able to successfully understand the positives and negatives of each individual stock and how they performed over the span of 5 years and compare it to S&P.

The interesting observations that we found were that one of the companies had a negative return and was performing pretty badly compared to the rest. Frontier Communications (FTR) was the company who had negative returns and was performing poorly whereas Electronic Arts (EA) was the company that had the highest Average Return. But, when we compared our observations to S&P 500, we found that PNC Financial Services (PNC) had the highest beta compared to the rest. The average beta of the market is 1 and the highest beta of the individual stock is of PNC, which is 0.914 so, we can say that all these individual stocks have less systematic risk than the market.

Table 2:

Panel A:

Panel B:

Analysis Overview of Table 2:

None of the covariances are particularly noteworthy. All of the pairs had a covariance of absolute value less than 0.01, and all but five of the pairs had a covariance less than 0.001. This would suggest that the stocks are not particularly correlated and therefore there can be risk reduction gained through diversifying with these securities. While true for most of the pairs, the next table demonstrates that this is certainly not the case for all of them.

Generally speaking, the correlations between each of the securities were relatively low, with all but five of the 45 asset pairs having a correlation less than 0.3. Ten of the pairs were negatively correlated. While this is perhaps not the best set of assets to work with, there should be a fair amount of risk reduction to be had by constructing a portfolio of these securities.

No specific company had a particularly high number of negative correlations, though Frontier Communications (FTR) had the most. This is not surprising given that it has a negative expected return. Amgen Inc. (ARG), Kellogg Co. (K) and PNC Financial Services (PNC) had no negative correlations, but given that they represent health care, processed food, and financial services, all of which will be in demand regardless of the economic state, this is not surprising either. Lastly, Duke Energy (DUK) and XCEL Energy Inc. (XEL) had a very strong positive correlation, far higher than any of the other pairs of companies. They are in similar industries, so it might be a good idea to replace one of these two securities with one that is less correlated with any of the others.

Table 3:

Analysis Overview of Table 3:

Graphs (Individual Firms):

Graphs (Portfolio):

Write-ups:

Q. How did your portfolio perform relative to individual stocks?

Answer)

Diversification analysis:

In the equally weighted portfolio, the portfolio outperformed most of the individual stocks (DUK, FTR, HOG, K, PNC, SRCL and XEL) after diversification when comparing to the average return. In the same sense, the equally weighted portfolio had higher risk than most of the individual stocks since higher return comes with higher risk. However, when it comes to Sharpe ratio, which is measuring the risk-adjusted return, the portfolio only outperformed two of the individual stocks (FTR and HOG).

In the value-weighted portfolio, the portfolio also outperformed most of the individual stocks when comparing to average return. It had lower risk for half of the individual stocks when we compared the standard deviation. Therefore, for the Sharpe ratio, it outperformed all of the individual stocks.

Lastly, in the optimal portfolio, the portfolio also outperformed most of the individual stocks for the average return. As for the risk, the optimal portfolio had the lowest risk than all of the individual stocks as it had the smallest standard deviation. As a result, the optimal portfolio had higher Sharpe ratio than all of the individual stocks as it was well diversified.

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