Investment Portfolio

All equity investing is risky, by simple virtue of the fact that companies can and do go bankrupt, wiping out their equity and taking share values down to zero. Even without bankruptcy, stocks can fall in value and remain at low levels, representing a loss to the shareholders. Risk is typically measured against key stock market indices, such as the Dow 30 or the S&P 500. Modern portfolio theory holds that by building a diversified portfolio, much of the firm-specific risk can be eliminated. Total market risk remains, but in theory the fluctuations of one firm or industry are offset by movements in the opposite direction of other stocks within the portfolio (McClure, 2011).

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A diversified portfolio can be obtained using a relatively small number of investments, if those investments are sufficiently diversified from one another. A portfolio should therefore consist of securities in different industries sectors and from countries around the world. As a result, it is important to choose stocks carefully, so that they increase the total diversification within a portfolio. In addition, the stocks chosen should be from companies with strong growth prospects in general — while diversification is the ultimate goal if the companies chosen are all strong they may be able to outperform the market in the long run.

This portfolio will be constructed with both diversification and long-term growth in mind. There will be 15 securities in six major industry sectors, plus a 10% cash component. This paper will outline the case for each component of the portfolio, and will provide background information on the different companies to justify their inclusion in the portfolio.

Investment Goals

The portfolio will be constructed with a long-term time horizon in mind. This is an important characteristic of portfolios constructed according to the principles of modern portfolio theory. In the short-run, diversification is unlikely to provide complete immunity from firm-specific shocks, because the timing of sharp movements is unpredictable and arbitrary. It is only with the passage of time that movements are likely to offset one another. The time horizon is important for the selection of companies, because a short-run perspective would imply that the companies selected should all have strong short-run prospects. This is not necessarily going to result in a fully balanced portfolio. In addition, for most investors an equity-weighted portfolio is only appropriate for those with a long-term time horizon. Equity markets are highly volatile relative to many other investment instruments, so the equity portion of any investment portfolio is typically viewed as the long-term portion.

In general, the objective of a balanced portfolio is to match the market performance. Historically, this is average market return is 6.3% (Burtless, 1999). This forms the core of our investment objectives. However, there are two adjustments to this core objective. The first is that for safety purposes, 10% of this portfolio is going to be held in cash. These funds will be invested in Treasury bills, which currently have a very low short-term rate of return. This will reduce the total returns of the portfolio. The other adjustment is that a portfolio selected on the basis of individual stock selection should outperform the broad market. If matching market performance is the sole objective, this can be achieved in a relatively risk-neutral manner with the purchase of an Index fund or an exchange-traded fund such as RSP on the New York Stock Exchange, which provides weighted exposure to all of the firms in the S&P 500. Thus, selecting individual stocks by its nature is an activity oriented to generating superior returns on a risk-adjusted basis. The diversification of the portfolio is intended to deliver the risk of the broad market, but the specific stock selection is intended to deliver superior returns.

When these ideas are combined, our approach becomes evident. The first part of the strategy is to identify the broad investment categories that will effectively mirror the broad market. The second element is to find those companies that can provide above-average growth and/or consistent dividends. This places emphasis on firms with strong long-term prospects, rather than those that are presently hot but have limited long-term upside. If this strategy is effective, the resulting portfolio will deliver superior growth at market level risks, thereby outperforming the broad market.

The risk tolerance that underlies this portfolio is a high risk tolerance. It is assumed that the investor is relatively young, and does not need this money for at least ten years. The $100,000 in this portfolio does not comprise the sum total of the investor’s wealth, but rather comprises of discretionary funds. The long time frame and the fact that the money is not needed for the essentials of daily life or any expected expenditures allows for the high risk tolerance. A high risk tolerance allows the portfolio to be oriented towards long-term equity investing.

Rationale for Asset Allocations

When determining asset allocations, the most important factor is to look at the industries that drive global growth and will continue to do so over the coming years. No matter what happens in the economy as a whole, there are certain segments that will continue to drive growth, and those are the segments that lead the market and the segments in which we want to be invested. There are a number of different factors that should be taken into account when analyzing the different industries. These include the pace and drivers of economic recovery and the impact that broad-based global trends are going to have on different industries around the world.

In the long-run, the world is seeing a population explosion, most of which is taking place in the developing world. Many developing world nations are also rapidly industrializing. This places significant demand on commodities, the supplies of which are generally constrained. As a result, commodity prices are generally increasing. This points to the value of being invested in key commodities — mining stocks and the oil & gas business.

The population trends indicate that there is considerable growth potential in the developing world, more so than in the traditional core markets of North America and Europe. Foreign stocks — which are traded in New York as American Depository Receipts (ADRs) — should therefore be an important component of the portfolio. In addition, technological innovation is a key source of growth. Therefore it is important to maintain some representation from the technology sector in any growth-oriented portfolio.

Lastly, population growth and the prospects for a long-term economic recovery highlight the value of being involved in consumer sectors, either at the retail or manufacturing level. A balanced portfolio should include elements of products for which there is everyday demand. Consumer durables are often a source of stability in a portfolio, and the biggest consumer durables or retailing companies offer an element of low risk that can be utilized to offset some of the volatility associated with other elements in the portfolio.

The following chart presents the asset allocation that has been selected for the portfolio:

Each component of this portfolio plays a specific role within the context of the overall portfolio. Precious metals are often viewed as a safe haven when other investment instruments are facing downturn. Thus, precious metals can be expected to move counter to some of the other elements in the portfolio, providing some insulation from political uncertainty and inflation. The oil and gas sector is going to benefit from long-term demand increases. The production of oil and gas is subject to finite supply, political uncertainty and increasing demand as the world industrializes. There is only one direction for oil and gas prices to go — up. Consumer staples was included to help stabilize the portfolio. ADRs give the portfolio greater access to the growth in international markets. Technology is a global growth driver. Industrials are like consumer staples — good for stability. Cash is the most stable element of the portfolio.

Individual Stock Selection

There will be fifteen stocks in total. Within each industry segment, there will be two or three stocks that are selected. The mining segment comprises 10% of the total portfolio. The firm selected are Newmont Mining is a Denver-based gold and silver producer and will comprise 6% of the portfolio. The other mining firm will be Sterlite Industries, a Mumbai-based copper producer that also has upside in alternative energy. Sterlite will also comprise 4% of the total portfolio. The industrial segment will consist of Caterpillar 5%), the heavy equipment maker and Boeing, the aircraft maker and defense contractor (5%). The oil and gas sector will comprise 20% of the total portfolio. Firms selected will include Texas-based Valero, a refining and retailing petroleum firm; Encana, the massive Canadian gas producer; and Exxon Mobile, the oil giant. In consumer durables, General Motors and Molson Coors have been selected. Three ADRs have been selected. These include Chinese search engine Baidu; the Brazilian petrochemical company Braskem and Irish pharmaceutical company Elan. For technology stocks, cutting edge retailer Amazon is included along with Taiwan Semiconductor and Cerner, a company that is focused on it solutions in the health care industry, which promises to be a rapidly growing sector as the result of demographic shifts and new health care legislation.

A common thread through these fifteen stocks is that they not only represent diversification as a group, but most of the companies chosen also have a range diversification within the company’s operations. The companies are spread around the world, and include a number of sectors. For example, within technology the portfolio has access to the health care sector through Cerner; within ADRs there is exposure to the Internet, chemicals and pharmaceuticals. This level of diversification will only help the portfolio to achieve its objectives in the long run. Each of these stocks will have between 5-7% of the portfolio, totaling 90%. The remaining 10% will be held in a U.S. government Treasuries. The use of treasuries is to allow for some degree of safety in the portfolio, as Treasuries do little more than cover expected inflation. The current rate on 10-year federal government paper is 3.40% (Yahoo! Finance, 2011). The coming pages will outline the specific financial information for each of these companies in detail. This will be following by a total portfolio analysis at the end of the report.

Newmont Mining

Newmont Mining (NYSE: NEM) is a gold and silver producer and has seen its earnings per share (EPS) improve steadily in recent quarters. The most recent quarterly EPS was $1.16. In 2010, Newmont earned $4.63 per share. The book value per share was $27.08, giving a price to book of 1.86. Net income was $2.305 billion. The current dividend is $0.60, or 1.1%. The 52-week high is $65.50 and the 52-week low is $48.20. Stockholder equity is valued at $13.345 billion and the firm’s market cap is $29.92 billion. The beta for Newmont is 0.36, which indicates that the firm has considerably lower risk than the general market.

The prospects for Newmont going forward are good. Gold and silver are important commodities that represent a safe haven. While the value of these commodities is often volatile, it often moves against the broad market — investors fleeing falling stocks move their money into precious metals. There is considerable uncertainty in the global economic environment, and the failure of leading economies to address their financial crisis with economically sound ideas is contributing to the prolonged high value of precious metals. Newmont is a sound company within the gold and silver space because it has taken steps to control its costs over the past few years and thereby increased its margins. This will position the company to outperform similar stocks should the precious metals market begin to fall.

Sterlite Industries

The second mining stock is Sterlite, a copper producer from India. Sterlite market cap is $12.62 billion and its beta is 2.38. The company reports in rupees, but these will be converted to dollars using the current exchange rate from Oanda, which is 45.3552 rupees to the dollar. Sterlite’s net income in fiscal 2010 was $865 million, or $0.265 per share. The P/E ratio is 53.8 times, and the price to book ratio is 5.85 times. The company is not currently paying a dividend. The 52-week high is $19.92 and the 52-week low is $12.58. The total equity book value is $842 million. Sterlite’s business is strong because the company is focused on the copper market. The price for copper is on a general long-term increase, from just over $3.60 per kilogram in June 2010 to a current price around $3.75. Demand for copper is increasing strongly, especially in emerging markets. Sterlite’s main business is in India, a rapidly growing international market with a high demand for metals like copper.

Sterlite is the largest copper producer in India, which gives it significant upside as the Indian economy continues to improve. Its presence in the portfolio therefore provides exposure to the Indian economy in general and to the increasingly lucrative copper market. Although this stock is volatile, its volatility is in part counteracted by the use of the very stable Newmont as the other component of the precious metals stock. The two combined have a weighted average beta of 1.37, which is somewhat risky, but not unduly so.

Caterpillar

Caterpillar is a heavy equipment maker in the industrials category. The company makes construction and mining equipment and therefore is a way to gain exposure to both of those industries. The company is also expanding rapidly into a number of developing regions such as Brazil. Caterpillar’s net income is $2.07, with an EPS of $4.15. The company’s P/E ratio is 26.11. The market cap is $69.23 billion. The price to book ratio is 6.40 times. Caterpillar pays a dividend of $1.76, giving a dividend yield of 1.6%. The beta is 1.88. The 52-week high is $108.90 and the 52-week low is $54.89. The book value of the company’s equity is $10.864 billion.

Caterpillar is a diversified company with a strong global presence. Its exposure to multiple industries makes it more stable than many other industrial manufacturers. While the company suffered in 2009 with respect to revenues and profits, it rebounded in 2010, indicating that for Caterpillar at least the recession is over. Its industry is highly competitive, but Cat has earned top spot in many segments and many countries, so it is well-positioned to continue growing steadily in the future, especially when the construction sector begins to recover in developed nations.

Boeing

The other investment in the industrial sector is blue chip Dow 30 company Boeing. Boeing’s business is split almost evenly between the aerospace and defense sectors. This gives the portfolio exposure to both sectors. Aerospace has been a growing sector as competition in the airline industry has intensified. Given that the industry is a virtual duopoly, Boeing stands to gain from general industry growth. Its defense business looks steady going forward as the U.S. Department of Defense typically spreads contracts around its key contractors, and there is steady demand from other nations.

Boeing’s most recent net income is $3.3 billion, for an earnings per share of $4.48. The company has a book value per share of 3.76 times. The P/E ratio is 16.33 times. Boeing currently pays a dividend of $1.68, for a yield of 2.3%. The beta is 1.31. Boeing’s 52-week high is $76.00 and its 52-week low is $59.48. The book value of the firm’s equity is $2.766 billion and the market cap is $53.57 billion.

Boeing’s growth prospects relate not only to its strong market position but to two major trends in the global environment. Increased globalization and wealth ahs improved the outlook for air travel, especially as new firms have entered the industry with profitable business models. The increase in flights in Asia and the Middle East in particular has boosted the prospects for airplane manufacturers. Ongoing political instability is going to prove a boost to Boeing’s defense contract business, both in the U.S. And around the world. Nations are reluctant to cut defense spending significantly as there are always threats to geopolitical stability.

Valero

Valero is an oil and gas refining and marketing company, operating gas stations and refineries. Their operations are largely in the United States. Valero’s prospects tend to be tied highly to the price of petroleum. Because of globally limited supply and rapidly increasing demand in the developing world, the price of oil is on an upward trend that looks to continue unabated for a few more decades at least. Valero is well-positioned to take advantage of this, operating in the U.S. market where consumers have very low price elasticity of demand for gasoline. As the U.S. economy improves — of which there are signs it is doing slowly — the demand from consumers for gasoline should begin to increase.

Valero earned $922 million last year, for an EPS of $2.77. The current price/earnings ratio is 8.09 and the price/book ratio is 1.04 times. Valero is primarily a growth stock, paying a dividend of $0.20, which equates to 0.80% yield. The company’s 52-week high is $30.42 and its 52-week low is $15.49. The beta of Valero is 1.16. Valero’s purpose in the portfolio is as a source of long-run growth, given the prospects of the petroleum industry in general. There is significant upside for all players in the industry, and Valero gives the portfolio exposure to the U.S. market specifically, where demand is expected to continue to increase. Prices will rise, but in general consumers will not change their habits much, meaning that demand will not fall significantly even as prices (and profits) rise in the industry

Encana

Encana is one of the world’s largest producers of natural gas. The company’s main fields are in northern Canada, with some others in the U.S. And other parts of North America. Encana markets its gas primarily in Canada and the United States, so this company is a way to increase the portfolio’s exposure to the American energy market. The natural gas focus makes Encana a complement to Valero. There is considerable growth in the natural gas industry, and the dominant position that Encana holds, along with its strong relationships to governments on both sides of the border, gives it a strong position for long-run growth.

Encana earned $1.5 billion last year, for a total of $2.03 per share. The book value per share is $23.53. The price/book ratio is 1.46 times. Encana pays a dividend of $0.82 per year, for a yield of 2.4%. The company’s 52-week high is $35.25 and its 52-week low is $26.02. Encana has a market capitalization of $25.27 billion and the book value of its equity is $17.327 billion. The beta is 1.00, perfect correlation with the broad market. Despite this correlation, the upside in the natural gas market probably means that Encana will outperform the market in the coming years. The price of natural gas is expected to rise over the long-term, and the U.S. is becoming increasingly interested in energy that comes from politically stable regions, which should orient U.S. energy policy towards Canada going forward.

Exxon Mobil

Exxon Mobil is the largest company in the world by market cap, a Dow 30 component and one of the bluest chips of all. The company has operations around the world and is poised to capitalize on the growing demand for and decreasing supply of oil. Exxon Mobil gives the portfolio an element of stability but also exposure to the global oil industry, where Exxon Mobil is one of the most important companies.

Exxon Mobil recorded $30.46 billion in profit last year, for an EPS of $6.22. This gives the company a P/E ratio of $13.30 and a price/book ratio of $2.81. Exxon Mobil’s dividend is $1.76, which gives a dividend yield of 2.10%. The company’s market cap is $410.22 billion and its beta is 0.43, indicating that Exxon Mobil is a very stable addition to this portfolio. The total book value of Exxon’s equity is $146 billion.

Overall, the purpose of Exxon Mobil in this portfolio is to provide a source of long-term growth in the oil industry that is stable and globally diversified. Exxon Mobil provides all of these attributes. The company’s long-term growth projects well, as does its profitability, and the diversification of the company also implies that it will be able to capture a share of global economic growth as well.

General Motors

The new General Motors has seen a strong turnaround in its fortunes since it has emerged from bankruptcy. The company, under new leadership, has been able to better respond to consumer demand and looks to be well-positioned moving forward. GM is set to restore some of the U.S. market share that it lost over the years, as its brand name and distribution network remain strong. With better cars and a more reasonable cost structure, GM is much more competitive than it has been in years. As one of the largest consumer product companies, but one with significant upside, GM makes a great addition to this portfolio.

General Motors earned a net income of $4.76 billion last year, which is equivalent to $2.89 per share. This gives GM a price/earnings ratio of 10.86 times and a price/book ratio of 1.83 times. The company is not presently paying a dividend. The 52-week high for GM stock is $39.48 and the 52-week low is $30.20. The company has a market cap of $48.99 billion and the book value of its equity is $36.1 billion. The new GM stock has only been around for a couple of years and therefore no beta has been calculated for it. A beta of 1 shall be assumed in lieu of better information.

GM’s prospects are good going forward. The company’s stock price largely reflects the strengths of its prospects, but as GM was once a dominant consumer durables firm it can easily re-take that position. If it does, GM will be in good position to deliver above-average returns to this portfolio.

Molson Coors

The other consumer products firm in the portfolio is Molson Coors. The brewery giant has operations in four major beer markets — the U.S., Canada, the UK and Brazil — and is one of the largest breweries in the world. The industry is largely stable, despite some declines, but firms like Molson Coors are growing through acquisition. The company’s activity in the acquisitions market suggests that it will continue to add properties and that this activity will help propel value in the company going forward.

MolsonCoors recorded net income of $668 million last year, an earnings per share figure of $3.78. This gives the company a price/earnings ratio of $11.68 and a price/book ratios of 1.06 times. MolsonCoors has a book value per share of $41.75. The company pays a dividend of $1.12, for a yield of 2.6%. The 52-week high is $51.11 and the 52-week low is $39.89. MolsonCoors has a beta of 0.72 and a market cap of $8.25 billion. The total book value of the firm’s equity is $7.8 billion.

The low beta indicates that the presence of MolsonCoors in this portfolio is to lend stability. In particular, the stability of GM is unknown so it needs to be counterbalanced by a stable consumer products company. In addition, the consolidation within the brewing industry provides the opportunity for MolsonCoors to either enter the world’s large growth markets or to be a takeover target itself, in either case providing an opportunity for abnormal returns in the coming years.

Baidu

One of three ADRs in the portfolio, Baidu is a Chinese search engine, with a dominant market share in the Chinese market. Political interference to force Google out of the market has only solidified Baidu’s market position. The Chinese Internet business is growing rapidly along with other aspects of that country’s economy, and Baidu should play the same role in that Internet market that Google plays domestically, with similar growth rates.

Baidu.com reported net income of $536.55 million last year, delivering an EPS of $1.54. This implies a price/earnings ratio of $86.84 and a price/book ratio of 36.36 times. Baidu does not pay a dividend. The company is currently trading at its 52-week high of $135.00 and its 52-week low is $58.53. Baidu has a market cap of $46.52 billion and a beta of 1.61. The book value of the Baidu’s equity is $696 million.

These figures indicate that Baidu is a high risk play, because of the current value of its stock. This value, however, reflects a dominant position in what will eventually become the world’s largest Internet market. Baidu should essentially be able to duplicate Google’s success since its monopoly is essentially protected by the Chinese government. The market sentiment is that this company has incredible upside and very low risk — thus even at its current valuation it is likely to continue to increase in value.

Braskem

Braskem is a Brazilian petrochemical producer. Its presence in the portfolio as an ADR gives the portfolio exposure to the key growth market in Brazil and also to the petrochemical industry. Brazil is one of the fastest growing economies on the world and joins China and India as companies to which this portfolio is exposed. The purpose of the ADRs is to increase international exposure in strong industries, making Braskem a perfect candidate for inclusion.

Braskem reported net income of $1.14 billion last year, for an EPS of $2.84. This implies a price/earnings ratio of 8.68 times and a price/book ratio of 1.62 times. Braskem does not pay a dividend. The company’s 52-week high is $26.03 and its 52-week low is $10.17. The beta for Braskem is 1.44 and the market cap is $10.13 billion. The book value of Braskem’s equity is $2.634 billion.

The company’s financials are decent, but the main attraction is value. Gaining access to the high growth Brazilian market in the petrochemical industry at a P/E of just 8.68 times represents good value, a counter to the risk that Baidu presents as a high P/E stock. The company produces polymers and is generally a supplier to other firms in the industry who then manufacture based on Braskem’s materials. The company has also been on an acquisition trend of late, seeking to grow beyond its current status as the world’s 7th-largest petrochemical player.

Elan

The lone European stock in the portfolio, Elan is an Irish pharmaceutical company. This ADR brings the portfolio some European exposure as well as pharmaceutical exposure. The company is a value play, having suffered a significant decline in share price in the wake of the collapse of the Irish economy and some scandals with respect to the marketing of some of its drugs. Elan represents an opportunity to buy a good company when it is suffering a down market, and therefore it represents a good growth opportunity in the coming years as it rebuilds its business and the European economy moves to a slow recovery.

Elan lost $324 million last year, a loss of $0.56 per share. There is no trailing P/E but the forward P/E is 162.25; the price/book is 19.55 times. Elan does not pay a dividend. The company has a beta of 1.10 and a market cap of $3.81 billion. Elan’s 52-week high is $8.24 and its 52-week low is $4.25. The book value of its equity is $194 million.

It is important that within this portfolio are stocks that are at a relative low point, but are good companies. A value play like Elan can counter the high price paid for Baidu. While the company’s growth prospects are limited to slow, steady growth, its current management team has rebuilt the company thus far and when the European economy recovers, Elan should be able to participate in that growth.

Amazon.com

Amazon is the largest Internet retailer in the world, but has remained capable of strong growth. The company has achieved its success through a combination of strong branding and technological innovation. Amazon has long been the innovator in online retailing, and its techniques have become widely imitated. As a result of this sustained competitive advantage, Amazon has been able to continue to grow its business both domestically and internationally for many years.

Last year, Amazon recorded net income of $1.15 billion for an earnings per share of $2.53. The price/earnings ratio was 36.25 and the price/book was 10.82. Amazon does not pay dividends. The company’s 52-week high is $191.60 and its 52-week low is $105.80. The market cap is $77.1 billion and the beta for Amazon is 0.94. The book value of Amazon’s equity is $6.8 billion.

Amazon is a relatively stable technology stock, representing the potential of Internet commerce. Amazon has continued to grow in the U.S., but has also become active in overseas markets, a trend that is expected to continue. Amazon has maintained its technological leadership and its position as the number one online retailer seems more or less unassailable, meaning that it should be a strong growth stock for years to come.

Taiwan Semiconductor

Taiwan Semiconductor is one of the world’s leading manufacturers of semiconductors. The company’s fortunes are tied to the diffusion of computers and technology as the company supplies many leading firms in the industry. Technological innovation is critical to Taiwan Semiconductor’s future. In addition, this company provides more exposure to leading Asian growth markets in the portfolio.

Taiwan Semiconductor last year recorded net income of $5.2 billion, which equates to $1.00 per share. The P/E ratio is 12.28 times and the price/book ratio is 3.5 times. The company pays a dividend of $0.37, for a dividend yield of 3.10%. The 52-week high is $13.85 and the 52-week low is $9.30. The market cap of the company is $63.3 billion and the beta is 1.01. As with Amazon, Taiwan Semiconductor represents a relatively safe investment in the technology industry. The company’s products are widely used and its business is relatively stable. Yet, there remains potential for growth as world semiconductor demand improves. As a bonus, the company benefits from the recent Japan tsunami, which reduced the capacity of some of its competitors. In the long run, the growth for Taiwan Semi-is expected to b stable and consistent, as the company benefits from the continued industrialization of Asia and the continue proliferation of electronics around the world.

Cerner

Cerner is a health care it company, so its presence in the portfolio provides exposure both to the growing health care industry and to enterprise it as well. Cerner’s industry is poised to grow rapidly in the coming years for two reasons. The first is the aging U.S. population which is responsible for rapid growth in the health care business in general. The second is that the health care industry is moving rapidly to electronic health records and computer-assisted diagnosis. This highlights the value of having an it health care leader in the portfolio.

Last year, Cerner earned a net income of $237 million, for an earnings per share of $2.78. The P/E ratio is 39.05 and the price/book ratio is 4.75 times. Cerner does not pay a dividend. The company is currently trading at its 52-week high of $108.88 and its 52-week low is $72.05. The market cap of Cerner is $9.05 billion and the company’s beta is 0.98. The book value of the company’s equity is $1.905 billion.

Cerner represents access to a high growth sector of the market, and judging by the fact that the stock is at its 52-week high, the market agrees that the future for Cerner is bright. While the high price may diminish the immediate returns, it does indicate that this is a company well-positioned to capture an increasing share of a rapidly growing it market in the U.S.

Total Portfolio Analysis

The purpose of diversification is to eliminate most firm-specific risk. A well diversified portfolio should therefore have a beta that is similar to that of the broad market. The total portfolio beta is taken as a weighted average of the betas of the individual securities within the portfolio. The following chart shows this calculation:

Firm

Weight

Beta

Portfolio Beta

Cash

0.1

0

0

Newmont

0.06

0.36

0.0216

Sterlite

0.04

2.38

0.0952

Caterpillar

0.05

1.88

0.094

Boeing

0.05

1.31

0.0655

Valero

0.06

1.16

0.0696

Encana

0.07

1

0.07

Exxon Mobil

0.07

0.43

0.0301

General Motors

0.05

1

0.05

Molson Coors

0.05

0.72

0.036

Baidu

0.07

1.61

0.1127

Braskem

0.07

1.44

0.1008

Elan

0.06

1.1

0.066

Amazon

0.07

0.94

0.0658

Taiwan Semi

0.07

1.01

0.0707

Cerner

0.06

0.98

0.0588

Weight

1

1.0068

The total portfolio beta is 1.0068, indicating that the portfolio is fully diversified. The highest risk company, Sterlite, is given a lower weighting in its grouping than the low-risk Newmont in order to balance the risk associated with the mining component of the portfolio. The no-risk money portion of the portfolio helps to balance the slight excess of risk in the other securities. Most of the securities are in a relatively small portion of the portfolio, to maximize diversification. Each individual security’s allocation represents its weight at the time the portfolio is set up, so for example Taiwan Semiconductor at 0.07 is 7% of the portfolio, or $7,000. The total portfolio adds up to $100,000, including the $10,000 in Treasuries.

In general, the portfolio has exceptional diversification because it includes not only a wide range of industry sectors but geographical sectors as well. Key industries such as defense, pharmaceuticals, oil, gas, Internet, automobiles, semiconductors, health care and copper are all represented. Most of the world’s major economies are also represented in this portfolio, including China, Brazil, India and of course the United States. All of the companies in the portfolio are attractive, but for different reasons. There value plays that are good companies at attractive prices, and there are high-potential companies that are trading at the tops of their respective ranges. In all cases, however, there are strong underlying factors that will drive growth of these firms in the future and that is the reason for their inclusion in the portfolio.

Conclusion

The objective of this portfolio is to earn superior returns at a market rate of risk. The market rate of risk is reflected in the portfolio’s beta, which sits as 1.0068. The industries chosen are strong growth industries around the world. Within each of these industries, firms were selected for their ability to fill a particular role in the portfolio. Blue chip companies were added for stability, while upstart companies with high volatility represent growth opportunities. Many of these companies are industry leaders, or have distinctive competencies that should carry them forward in the next ten years to become industry leaders.

The betas of the different securities reflect the past performance of the company in question. The portfolio was also designed with future performance in mind, so particular attention was paid to companies that are profitable (14 of 15 companies) and have high growth prospects going forward. In a diversified portfolio, the stocks chosen need to be those with the potential to exceed their past performance, if the portfolio is to outperform on a risk-adjusted basis. Just as this portfolio illustrates how diversification reduces company-specific risk, it also provides a lesson on how to be selective in choosing stocks so that even a portfolio with a beta of 1.00 has the potential to outperform the broad market going forward.

Works Cited:

McClure, B. (2011). Modern portfolio theory: Why it’s still hip. Investopedia. Retrieved March 25, 2011 from http://www.investopedia.com/articles/06/MPT.asp

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Yahoo! Finance: Sterlite Industries. Retrieved March 25, 2011 from http://finance.yahoo.com/q?s=slt&ql=1

Yahoo! Finance: Newmont Mining. Retrieved March 25, 2011 from http://finance.yahoo.com/q?s=nem&ql=1

Yahoo! Finance: Caterpillar. Retrieved March 25, 2011 from http://finance.yahoo.com/q?s=CAT&ql=0

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Yahoo! Finance: Boeing. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=BA+Key+Statistics

Yahoo! Finance: Valero. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=VLO+Key+Statistics

Yahoo! Finance: Encana. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=ECA+Key+Statistics

Yahoo! Finance: MolsonCoors. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=TAP+Key+Statistics

Yahoo! Finance: General Motors. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=GM+Key+Statistics

Yahoo! Finance: Baidu.com. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=BIDU+Key+Statistics

Yahoo! Finance: Braskem. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=BAK+Key+Statistics

Yahoo! Finance: Elan. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=ELN+Key+Statistics

Yahoo! Finance: Amazom.com. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=AMZN+Key+Statistics

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Yahoo! Finance: Cerner. Retrieved March 25, 2011 from http://finance.yahoo.com/q/ks?s=CERN+Key+Statistics