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# Portfolio Project Report, Term Paper Example

Pages: 8

Words: 2066

Term Paper

The purpose of this project is to gain a sharper understanding of the price earnings ratios, how the stock market works, as well as how to make smarter decisions when choosing what stocks to trade.

P/E ratio, i.e. the relationship between the price or value and benefits, is a geometric reason that is used in the fundamental analysis of companies, especially in those quoted on the stock exchange. Its value indicates how many times you are paying annual net profit of a particular company to buy an action of this. A P/E ratio higher implies that investors are paying more for each unit of benefit.

The value of price is calculated by dividing the price of the action of a particular company in the stock market between the annual net profit after tax of the company concerned between the number of shares that has issued (profit per share). In other words, Peru of a company is calculated by dividing the price of each action between the BPA (profit per share).

If a company has a per high may mean that the expectations of the value are favorable and are anticipating a growth of the benefits in the future. Although we can also mean that the price of the action is overpriced and therefore is unlikely to the quote follow up.

Although it is a simple indicator of calculation, the P/E is quite difficult to interpret. It can be very informative in some situations, although other times are meaningless. As a result, investors often use poorly this term and put more value in the P/E of which is required.

Most of the times, the P/E is calculated using the gain by the action of the last four quarters. This is known as a follow-up to P/E. However, occasionally the earnings per share are taken from estimated earnings that are expected in the next four quarters. This is known as P/E projected. A third variation uses the earnings per share for the last two quarters and estimated the next two quarters.

There is a great difference between these variations, but it is important to understand that in the first calculation, we are using historical data. The other two calculations are based on analytical estimates that are not always perfect or precise.

The companies that are not profitable, and as a result they have negative earnings per share, represent a challenge to calculate the P/E. There are various views on how to resolve this. Some say that there are P/E negative, others prefer a P/E of 0, while the majority argues that the P/E does not exist.

Although the gains by action in the P/E are normally based on profits of the last four quarters, the P/E is more than the measurement of the past performance of a company. It also takes into account the market expectations for the growth of a company.

Remember, the prices of the actions reflect what they think investors about what is worth a company. Future growth is already counted in the price of the action. As a result, a better way to interpret the P/E ratio is a reflection of the optimism of the market according to the growth prospects of a company.

If a company has a P/E greater than the average of the market or of the industry, means that the market is expecting great things for the coming months or years. A company with a high P/E ratio will eventually have to comply with the high rating increasing substantially their profits, or the share price will have to fall.

Until now we have learned that in the right circumstances, the P/E ratio can help us to determine if a company is on or undervalued. But the analysis of P/E is only valid in certain circumstances and has its traps. Some factors that can undermine the usefulness of the P/E ratio are:

Inflation: In times of high inflation, depreciation costs and inventories tend to be underestimated because the replacement costs of goods and equipment are raised along with the general level of prices. Thus, the P/E ratios tend to be lower in times of high inflation since the market sees profits artificially distorted upwards. As with all the ratios, is more valuable to see the P/E in time to determine the trend. Inflation makes this difficult, since the information passed is little useful today.

Various interpretations: a low P/E ratio does not necessarily mean that a company is undervalued. Rather, it can mean that the market believes that the company is directed toward future problems in the short term. The actions that fall, it is usually for some reason. It may be that the company has warned that the winnings will be lower than expected. This would not be reflected in a follow-up to P/E until the earnings are revealed, and in that time the company could be undervalued.

A common mistake among investors beginners is the sale in the short of actions because they have a high P/E ratio. As the first point, we believe that the novice should not use this technique. Secondly, we can engage in many problems valued actions using only simple indicators such as the P/E ratio. Although a high P/E ratio could mean that the action is overrated, there are no guarantees that will lower soon. On the other hand, even if an action is undervalued, it can take years to the market the value appropriately.

The analysis of actions requires considerably more to understand some ratios. Although the P/E is a part of the puzzle is definitely not a crystal ball. The ratio PEG (Price/Earnings To Growth, i.e. price/benefit to growth), is a measurement that relates the market value of an action, the benefits for Action and the expected future growth of the company.

A low ratio indicates to us that the action is undervalued in bag. A higher ratio indicates to us that the action is overrated. Its validity is called into question for certain extreme situations as sectors with little growth. In general terms, is typically applied only for growing businesses (companies whose growth is higher than the average rate of return of the stock market).

Advantages: incorporates the concept of growth compared to the ratio of per traditional.

Disadvantages: Its use is doubtful for companies in ends (with much growth or with little growth); in addition, we must not forget that the rate of growth is an estimate, which can lead to different conclusions for two analysts on a same action.

My initial picks in portfolio project 1 were Barclays, Boeing, Sanofi, Nestle, LVMH, and Yahoo. The week 1 performance for these four companies only resulted in gains Barclays and LVMH, as where Sanofi and Nestle suffered losses. I chose these companies because they are in different industries but still hold strong positions in the stock market.

Investors should maintain a string of the risk free assets and a market portfolio. The true market portfolio consists of a large number of securities, and an investor would have to own all of them in order to be completely diversified. Because owning all existing securities is not practical, we will consider an alternate method of constructing a portfolio that may not require a large number of securities and will still be sufficiently diversified. Consider the reduction in risk as we add more and more securities to a portfolio. As can be see, much of the nonsystematic risk can be diversified away in as few as 30 securities. These securities, however, should be randomly selected and represent different asset classes for the portfolio to effectively diversify risk. Otherwise, one may be better off using an index (e.g., the S&P 500 for a diversified large-cap equity portfolio and other indices for other asset classes).

Any security not included in the S&P 500 can be evaluated to determine whether it should be integrated into the portfolio. That decision is based on the ?i of the security, which is calculated using the CAPM with the S&P 500 as the market portfolio. Note that security i may not necessarily be priced incorrectly for it to have a non-zero ?i; ?, can be positive merely because it is not well correlated with the S&P 500 and its return is sufficient for the amount of systematic risk it contains. For example, assume a new stock market, ABC, opens to foreign investors only and is being considered for inclusion in the portfolio. We estimate ABC’s model parameters relative to the S&P 500 and find an ?i of approximately 3 percent, with a 13, of 0.60. Because a ?i is positive, ABC should be added to the portfolio. Securities with a significantly negative a, may be short sold to maximize risk-adjusted return. For convenience, however, we will assume that negative positions are not permitted in the portfolio.

 Totals 112942 from portfolios Mean 22588.4 Variance 587779370.64 Standard Deviation 24244.161578409 CV 1.19999

Treynor’s measure = rp-Rf/Beta, where Betap, = COV(rp3rm)/ 587779370.64 (rm) = 57.907

1. Sharpe’s ratio= rp-Rf/24244.161578409p =85.001
2. Jensen’s alpha= rp-rm =43.817

In addition to the securities that are correctly priced but enter the portfolio because of their risk—return superiority, securities already in the portfolio (S&P 500) may be undervalued or overvalued based on investor expectations that are incongruent with the market. Securities in the S&P 500 that are overvalued (negative ?i) should be dropped from the S&P 500 portfolio, if it is possible to exclude individual securities, and positions in securities in the S&P 500 that are undervalued (positive ?i) should be increased. A complete analysis of portfolio optimization is beyond the scope of this concept, but the following principles are helpful. The weight in each nonmarket security should be proportional.

The companies I chose for my portfolio 2 project were Abercrombie, Taxi, Air France, and Rolls Royce. All of these companies experienced gains in their week 1 performance. In week 2, all of the companies except for Rolls Royce suffered losses. Then in week 3, all the companies again experienced gains. In general, the performance of all portfolios resulted various fluctuations based on the positions of the stock market at the time.

There are first the various types of assets that any investor must consider. These assets or securities can range from buying stock to the foreign exchange markets. Accurate asset selection is important to generate the highest return on investment. The foreign exchange market can carry risks as exchange rates are constantly fluctuating. It is important to look at where the exchange rate stands for any foreign investments as they effect the utility curve.

We can further extend the analysis of a risky asset to a portfolio of risky assets. For convenience, assume that the portfolio carries all accessible risk prone assets, although an investor may not wish to include all of these assets in the portfolio because of the investor’s specific preferences. If an asset is not included in the portfolio, its weight will be zero. The suggestion that portfolios have lower risk than the assets they contain may seem counterintuitive. These portfolios can be made, however, assuming the assets in the portfolio are imperfectly correlated. As an illustration of the effect of asset weights on portfolio characteristics, consider a simple two-asset portfolio with zero weights in all other assets. Assume that Asset 1 has a return of 10 percent and a standard deviation (risk) of 20 percent. Asset 2 has a return of 5 percent and a standard deviation (risk) of 10 percent. Furthermore, the correlation between the two assets is zero. Exhibit 1 shows risks and returns for Portfolio X with a weight of 25 percent in Asset 1 and 75 percent in Asset 2, Portfolio Y with a weight of 50 percent in each of the two assets, and Portfolio Z with a weight of 75 percent in Asset 1 and 25 percent in Asset 2.

In conclusion, I have accumulated much knowledge of stock market valuation based on these portfolios. I have learned that the stock market is constantly fluctuating which is why there is a need to pursue the proper measurements of portfolio performance before making any large investments. My own argument would be that although investors want an asset that makes the greater return and carries with it the least risk, this asset doesn’t exist. As the risk—return capital market theory illustrates, one should assume a greater risk in order to earn a higher return. We can improve an investor’s portfolio, however, by expanding the opportunity set of risky assets because this allows the investor to choose a superior mix of assets.

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