Part 2: Investment Portfolio Review (45 marks total)
Part 1: Mutual Funds (20 marks)
- Go to GlobeFund or Morningstar and select six mutual funds, according to the following requirements:
- one index fund
- one dividend fund
- one global fund
- three equity funds in different sectors such as energy, technology, microcaps, income, etc.
- Prepare a table showing each fund’s load fees (if any), MER, and return over one, three, and five years and from inception. Identify which fund is, in your opinion, the best to invest in considering short- and long-term returns, load fees, and MERs. Explain why you picked this fund.
Part 2: Investment Portfolio Review (45 marks total)
Your response to Part 2 should be between 750 and 1250 words, with complete calculations shown where required. Based on the stocks of the two companies you chose in Last Assignment(Dollarama and Toronto-Dominion Bank) Preparation and worked on in Assignment, answer the following questions:
- Calculate the total return percentage achieved for each individual stock from the day you selected the stock to the present or most recent business day. Use the formula
End Share Price – Beginning Share Price + Dividends Received (if any)/Beginning Share Price.
(5 marks)
- Annualize the percentage return for each stock; that is, calculate what your return would be if you held the stock for one year. To do this, take your returns from above, divide by the number of days the share was held, and multiply by 365.
(2 marks) - Calculate the annualized return for the portfolio. (Use an equal weighting for each stock.) Was your return higher or lower than the rate of inflation? (3 marks)
- Compare your annualized return with that of the index from which you have chosen your stocks. For example, if your stocks were chosen from the TSX, compare your return with that of the S&P/TSX Composite index over the past year. If you chose stocks from more than one index, you may have to compare one return with one index and the other return with another index. If, for example, you have one stock from the TSX, you would compare your stock average annual return with the S&P/TSX Composite index. Then, supposing the other stock you chose was traded on the NYSE, you would compare these returns with the S&P 500 index. In one paragraph, explain why each return is greater or less than the index. (10 marks)
- For each of your stocks, identify (in one sentence) the most significant variable that explains the performance of the stock. For example, if you held U.S. bank stock and your stock has generated a 10% loss, you might identify the U.S. housing market as the most significant variable affecting the stock’s average return. (5 marks)
- In two paragraphs, describe the concept of “return versus risk,” and explain how you would use it in selecting a new investment portfolio. Explain how and why you used (or did not use) this concept when you chose your original two stocks. In your explanation, ensure that you answer the following questions:
- What would you do differently if you were to choose another two stocks for your portfolio? Explain your answer. (10 marks)
- What specific actions could you take in the future when choosing stock investments to reduce risk and increase the reward in your portfolio?
(10 marks)
Part 3: Learning from the Masters (35 marks total)
Your response to Part 3 should be no more than 1000 words, with complete calculations shown where required. Use the lesson notes from Lesson 6 to answer the following questions. If appropriate, you may use tables to present information.
- Compare the investment philosophy you used to select your two stocks with that of Benjamin Graham. What would Benjamin Graham say about your stock picks? Provide a reason your choice may be different than Mr. Graham’s. (10 marks)
- Warren Buffett does not invest in Internet companies due to the difficulty in predicting their future earnings. Explain to Mr. Buffett how he could value an Internet company that at present has no cash flow. Use financial calculations as appropriate to answer this question. (10 marks)
- Choose five of the masters listed in Lesson 6. Compare and contrast their investment styles, using a table if appropriate. Which of the masters’ investment styles do you believe will be most effective over the next ten years? As an investment advisor, which of these investment styles would you use during a bull market? During a bear market? Be sure to fully explain each of your responses. (15 marks)
Lesson 6 for Part 3 here under please and this will help you solving part 3
Lesson 6: Learning from the Masters
Notes
Note 1: Benjamin Graham
Benjamin Graham began a career on Wall Street at the age of 20. By 1919, he was 25 years old and earning $600,000 annually. In 1926, he formed an investment partnership, Graham-Newman, where a list of prominent investors (including Warren Buffett) later worked. Graham is remembered as the founder and father of value investing. He might also be credited with the development of rigorous security analysis. His book The Intelligent Investor is regarded as a classic for investors. In 1934, he collaborated with David L. Dodd to write Security Analysis. It has since become known as Graham and Dodd’s Security Analysis, and its fifth edition was revised by three prominent professionals and academics, Sidney Cottle, Roger F. Murray, and Frank E. Block.
Graham thought extensively about the meaning of investment versus speculation. When he started his career, stocks were considered a speculation, while bonds were considered an investment. The great crash of 1929 showed that bonds can be as speculative as stocks. In Graham’s opinion, it was the intention of the investor, more than the character of the transaction, that would determine whether a transaction is an investment or a speculation.
Graham (1973) defined an investment operation as “one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative” (p. 1). In other words, for a security to be considered an investment, there must be some degree of safety of principal and a satisfactory return. Analysis determines the degree of safety and the promise of income. Graham held that the value of an investment is not its earnings this month, or next month, or in the next quarter, nor what its sales volume will be next quarter; rather, its value is determined by what an investor can expect to receive over a long period of time. He described three phases of analysis (1973, pp. 145–146):
- descriptive analysis, where the analyst gathers all the facts and presents them
- critical analysis, where the analyst evaluates the security and the merits of the standards used to communicate information to the public (e.g., accounting standards) and management’s track record in communicating openly
- selective analysis, where the analyst decides on the merits of the security with a recommendation
Graham looked to buy undervalued stocks, those selling below their intrinsic value. He reasoned that a margin of safety existed for the common stock if the price of the stock was below its intrinsic value, which he determined from factual information such as the company’s assets, earnings, dividends, and any definite future prospects. Future earnings power is the determining factor in ascertaining the attractiveness of a stock and also a limiting factor for accuracy. Graham ventured into subjective territory when he advocated that a company’s intrinsic value can be found by estimating the future earnings and multiplying them with an appropriate capitalization factor. This methodology forms the basis for most modern financial analysis. The variety of methodologies employed by analysts shows how widely this method can range. For Graham, the difference between the intrinsic value (calculated) and the price of the company share should be large enough to create a margin of safety. Graham liked stocks with a low price to earnings (P/E) ratio and a low price to book value (market value to book value) ratio. Net asset value was Graham’s starting point. He liked to buy companies for less than two-thirds of their net asset value (preferring net current assets) and to focus on low P/E stocks with some net asset value. He also considered other factors beyond financial statement “facts,” including management capability and the nature of the business.
Graham looked at the past record of his potential investments, and the further back he could look, the better. If an analyst reviewed the company’s record of earnings and saw that it was able to annually earn five times the fixed charges, then its bonds possessed a margin of safety and its stock could be considered. He did not expect the analyst to accurately predict future earnings. For Graham, a reasonable estimation would suffice if the margin between earnings and fixed charges was large enough.
Graham found that growth stocks—stocks growing their sales and earnings at an above-average rate—were difficult to deal with and created a dilemma for investors. How do investors define the stage of growth in the corporate or product life cycle? If the investor buys during the company’s rapid growth stages, the growth may turn out to be temporary. If the investor can accurately pinpoint a growth company, what price should he or she pay? Graham said that to get a margin of safety, one should purchase the shares of a company when the overall market is trading at a…
