Franklin University MBA737 Equity Analyst Project

Franklin University

MBA 737
Equity Analyst Project
The Equity Analyst Project involves a total of three assignments:
1.
Individual Asset Allocation
Exercise
2. Team Analysis of Select Industry
Groups
Team
Analysis of Companies within an Industry Group
The intent of the project is to simulate a top-down, three-stage approach
to security analysis that proceeds with, first, an analysis of general economic
factors, then industry comparisons, and finally the analysis of individual
companies within a particular industry. Here
is justification for this approach:
The results of several academic
studies have supported this technique. First, studies indicated that most
changes in an individual firm’s earnings
could be attributed to changes in aggregate corporate earnings and changes in
the firm’s industry, with the aggregate earnings changes being more
important…
Second, studies…[have] found a
relationship between aggregate stock prices and various economic series, such
as employment, income, or production…
Third, an analysis of the
relationship between rates of return
for the aggregate stock market, alternative industries, and individual stocks
showed that most of the changes in rates of return for individual stocks could
be explained by changes in the rates of return for the aggregate stock market
and the stock’s industry.[1]

The following is provided as a guide to your analysis in these three
assignments:
Individual Asset Allocation Exercise
This
exercise involves an analysis of general economic conditions or systematic
risk, i.e., the risk that affects all industries and companies, in the U.S.
economy. You are asked to determine in percentage terms an optimal allocation
of $1,000,000 among the following three asset classes: U.S. equities, U.S.
Treasury bonds, and cash. The goal is to maximize your expected return over the
next 12 months. You are asked to write a 1-2 page paper providing your analysis
of the asset classes’ return prospects and your justification of your
allocation of monies among them.
First, consider historical returns on various asset classes in the U.S.
Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312 you can see that historically equities outperform
bonds in terms of average return but they also carry more risk as defined by
their standard deviations. These historical results show that on average the
return on equities is highest but in some specific years this may not be true.
For example, look at Table 10.1 on pp.308-309 and you can see that in three out of the five years
from 2000 to 2004 the annual return on large-company stocks (defined in the
text as the S&P 500)[2]
was negative.
In this exercise your investment horizon is one year. In considering your
allocation among U.S. equities, long-term Treasury bonds, and cash to maximize
your prospective return over the next twelve months, we might next more
precisely define these asset classes. We can define U.S. equities as the
Standard and Poor’s (S&P) composite index [“At present…includes 500 of the
largest (in terms of market value) stocks in the United States.” (p.304)]. More detailed information is
available directly from Standard & Poor’s:.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html”>http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html
Excel spreadsheets of Index returns dating from
2009 back to the late 1980’s are available at
.standardandpoors.com/spf/xls/index/MONTHLY.xls”>http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.

Web-based finance sites also
customarily carry data on the S&P 500. For example, –at Yahoo!
Finance:.yahoo.com/q?s=%5EGSPC”>http://finance.yahoo.com/q?s=%5EGSPC

–at CNNMoney.com:.cnn.com/data/markets/sandp/”>http://money.cnn.com/data/markets/sandp/?
–At MSN: .msn.com/detail/stock_quote?Symbol=$INX”>http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX

We can define long-term Treasury bonds as 30-year U.S. government bonds.
Historical data on yields on debt claims are available from the Federal Reserve
at .federalreserve.gov/releases/h15/data.htm”>http://www.federalreserve.gov/releases/h15/data.htm.
For historical on the 30-year T-bond, defined as “Market yield on U.S. Treasury
securities at 30-year constant maturity, quoted on investment basis” go to
http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn
Long-bond Treasury rates are also available from the following
sites:

— http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

— .bloomberg.com/markets/rates/index.html”>http://www.bloomberg.com/markets/rates/index.html
The third alternative is cash. Assume no return on that share of your
monies held in cash.
This analysis necessarily
involves your assessment of systematic risk, i.e., the risk that affects all
industries and companies, in the U.S. economy over the next twelve months.
Let’s more fully define systematic risk. According to the textbook, systematic
risk “…influences a large number of assets, each to a greater or lesser extent…[and
is] sometimes called market risk…Uncertainties
about general economic conditions, such as GDP, interest rates, or inflation,
are examples of systematic risks. These conditions affect nearly all companies
to some degree” (p. 343). Your task is to consider your investment alternatives in
light of systematic risk expected over the coming year.
Your
considerations about investing in U.S. equities will thus involve your
determination of the near-term prospects for the U.S. economy and the
implications of these prospects for U.S. equities.
A useful site for
recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/.
Click on the highlighted report or “Consensus” next to any particular report to
get data (either recently reported or the near-term consensus, respectively),
the schedule of future data releases, a definition, and, importantly for our
purposes, a section entitled “Why Do Investors Care?” More generally, many other sites provide
information on macroeconomic data, such as:
–.wsj.com/classroom/Indicators/guide.html”>http://info.wsj.com/classroom/Indicators/guide.html
–.bea.gov/”>http://www.bea.gov/

— .gpoaccess.gov/indicators/index.html”>http://www.gpoaccess.gov/indicators/index.html

–.stlouisfed.org/fred2/”>http://research.stlouisfed.org/fred2/

Finally, the
decision to invest in 30-year U.S. T-bonds importantly involves expectations
about future inflation and the term structure of interest rates, i.e., “the relationship between short- and long-term
interest rates” (p. 162). On p. 161 of the textbook the distinction is made
between “real” interest rates and “nominal” interest rates. “Nominal” interest rates are the rates that
are quoted in the financial press; they are the rates at which we borrow and
lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal
rate includes the so-called inflation premium, h, so that the higher the
expected inflation, h, the higher the nominal rate, all else equal. In
considering longer-term T-bonds one must also be aware that, in addition to
expected long-term inflation, there is greater interest rate risk: “…longer
term bonds have much greater risk of loss resulting from changes in interest
rates than do shorter-term bonds” (p. 164). Specifically, should
interest rates increase, the market value of 30-year bonds will fall and the
fall will be more dramatic for a 30-year T-bond than for a 10-year Treasury
bond. Conversely, price gains from any drop in rates will be more dramatic the
longer the term to maturity on a bond. One should also keep in mind that while
in general longer-term rates are typically higher than short-term rates for the
same level of overall risk, there have been occasions when the reverse is true,
and the term structure of interest rates is inverted. (Please see Figure 5.5 on
p. 163 on the historical relationship between long-term and short-term U.S.
interest rates.) Finally, in finance we assume that there is no credit or
default risk on Treasury securities. It is assumed that there is no risk that
the U.S. government will fail to meet its outstanding debt obligations. This
is, of course, not the case for corporate issuers.
Finally,
what are the implications of interest rate changes for the equity market? Here
is one response to this question: .investopedia.com/articles/06/interestaffectsmarket.asp”>http://www.investopedia.com/articles/06/interestaffectsmarket.asp
Questions for Individual Asset Allocation Exercise:
1.
Allocate your fictional
$1,000,000 among the following three asset categories:

Asset

U.S. Equities

U.S. 30-Year Treasury Bonds

Cash

Allocation

100%

2.
Justify your allocation based on
your outlook for systematic risk in the U.S. economy over the next year.
Team Analysis of Select Industry Groups
This analysis is
a team assignment that requires your team to analyze a select group of
alternative industries to determine which is most likely to perform best in terms
of growth and earnings over the next 12 months. Your instructor will create
your teams, ideally based on similar views about the near-term prospects for
the U.S. economy expressed in the Individual Asset Allocation Exercise.
To guide this
second stage analysis, you are asked to rely on theNorth
American Industry Groups database available at Yahoo! Finance. The system is
comprised of 9 macroeconomic sectors, 31 business segments and 215 industry
groups.This
database is readily accessible via Yahoo! Finance at
.yahoo.com/ic/ind_index.html”>http://biz.yahoo.com/ic/ind_index.html
To simplify the exercise the 215 industry
groups within the database have been reduced to a more analytically manageable
24 industry groups (each with public firms listed at Yahoo! Finance totaling no
less than 5 and no more than 15 companies) in 7 macroeconomic sectors as
follows:

Basic Materials
AluminumMajor Integrated Oil &GasNonmetallic Mineral Mining

Consumer
Goods
AppliancesConfectionersOffice
Supplies
Financial
REIT-Healthcare
FacilitiesREIT-Hotel/MotelREIT-Industrial
Healthcare
Drugs-GenericHome
Health CareHospitals
Industrial
Goods
Manufactured
HousingPollution
& Treatment Controls
Services
Advertising
AgenciesAir
Delivery & Freight ServicesDrug StoresElectronic
StoresHome
Improvement StoresJewelry
Stores
Technology
Computer
Based SystemsLong
Distance CarriersPersonal
Computers
Utilities

Water
Utilities
To access more details on these groups go
to .yahoo.com/ic/ind_index.html”>http://biz.yahoo.com/ic/ind_index.html
and click on any of the names of the 24 groups to go to each industry’s
“Industry Center” page. Additional useful information is available via the link
to “Industry Browser” on the left. Also, on each industry’s summary page click
on “Company Index” and then on “Public” on the subsequent page next to “View:”
to get the list of public companies in this industry. Our focus is on publicly
listed companies in which we might ultimately invest. The list of public
companies is provided alphabetically. Following each name is the company’s
ticker symbol in brackets. See .investopedia.com/terms/s/stocksymbol.asp”>http://www.investopedia.com/terms/s/stocksymbol.asp
or .investorwords.com/4968/ticker_symbol.html”>http://www.investorwords.com/4968/ticker_symbol.html
for brief definitions of stock/ticker
symbols.
Please note that on occasion the ticker symbol may also be followed by other letters,
such as PK or OB (see http://www.investopedia.com/ask/answers/04/022004.asp or .investopedia.com/ask/answers/120.asp”>http://www.investopedia.com/ask/answers/120.asp
for explanations). It is recommended that we ignore stocks so designated in
these exercises.
The goal of
this second stage in our equity analyst project is to select one industry out
of this list of 24 whose performance prospects you determine are best over the
next year. Here are some factors to consider when comparing industry groups:[3]

Degree of Competition in the IndustrySupply/Demand Dynamics for the Industry’s ProductsIndustry Cost StructureDegree of Government Regulation-Favorable or NotExposure to the Business CycleRelative Financial Norms and Standards
Your team
is asked to write a 5-10 page paper providing your analysis of the issues
involved in your selection of the industry group that you conclude is most
likely to prosper in the coming months and your justification of your choice of
that industry.
Assignment:Equity Analyst Project: Individual Asset Allocation Exercise

Purpose
To enable the student to
demonstrate proficiency in the first stage of a top-down, three-stage valuation
analysis: analysis of investment prospects in the U.S. macroeconomy.

Overview
This individual assignment
involves an analysis of general economic conditions or systematic risk, i.e.,
the risk that affects all industries and companies, in the U.S. macroeconomy.
You will be asked to determine in percentage terms an optimal allocation of
$1,000,000 among the following three asset classes: U.S. equities, U.S.
Treasury bonds, and cash. The goal is to maximize your expected return over the
next 12 months. You will be asked to write a 1- to 2-page paper providing your
analysis of the asset classes’ prospects and your justification of your
allocation among them.

Action
Items
1. Read the
Equity Analyst Project document that your professor will distribute during Week
1.
2. Conduct
any necessary research so that you can make a proper analysis.
3. Write a
1- to 2-page paper that provides your analysis of the three asset classes’
prospects and your justification of your allocation among them. Format your
paper according the.franklin.edu/myfranklin/GetCourseView.do?sectionId=38851#course-object-1382448651071″>Academic
Paper Guidelines.

Questions for Individual Asset Allocation Exercise:
1.
Allocate your fictional
$1,000,000 among the following three asset categories:

Asset

U.S. Equities

U.S. 30-Year Treasury Bonds

Cash

Allocation

100%

2.
Justify your allocation based on
your outlook for systematic risk in the U.S. economy over the next year.
Individual Asset Allocation Exercise
This
exercise involves an analysis of general economic conditions or systematic
risk, i.e., the risk that affects all industries and companies, in the U.S.
economy. You are asked to determine in percentage terms an optimal allocation
of $1,000,000 among the following three asset classes: U.S. equities, U.S.
Treasury bonds, and cash. The goal is to maximize your expected return over the
next 12 months. You are asked to write a 1-2 page paper providing your analysis
of the asset classes’ return prospects and your justification of your
allocation of monies among them.
First, consider historical returns on various asset classes in the U.S.
Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312
you can see that historically equities outperform bonds in terms of average
return but they also carry more risk as defined by their standard deviations.
These historical results show that on average the return on equities is highest
but in some specific years this may not be true. For example, look at Table
10.1 on pp. 308-309 and you can see that in three out of the five years from
2000 to 2004 the annual return on large-company stocks (defined in the text as
the S&P 500)[1]
was negative.
In this exercise your investment horizon is one year. In considering your
allocation among U.S. equities, long-term Treasury bonds, and cash to maximize
your prospective return over the next twelve months, we might next more
precisely define these asset classes. We can define U.S. equities as the
Standard and Poor’s (S&P) composite index [“At present…includes 500 of the
largest (in terms of market value) stocks in the United States.” (p. 304)].
More detailed information is available directly from Standard & Poor’s:.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html”>http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html
Excel spreadsheets of Index returns dating
from 2009 back to the late 1980’s are available at
.standardandpoors.com/spf/xls/index/MONTHLY.xls”>http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.

Web-based finance sites
also customarily carry data on the S&P 500. For example, –at Yahoo!
Finance:.yahoo.com/q?s=%5EGSPC”>http://finance.yahoo.com/q?s=%5EGSPC
–at CNNMoney.com:.cnn.com/data/markets/sandp/”>http://money.cnn.com/data/markets/sandp/?

–At MSN:.msn.com/detail/stock_quote?Symbol=$INX”>http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX

We can define long-term Treasury bonds as 30-year U.S. government bonds.
Historical data on yields on debt claims are available from the Federal Reserve
at.federalreserve.gov/releases/h15/data.htm”>http://www.federalreserve.gov/releases/h15/data.htm. For historical on the 30-year T-bond, defined as “Market yield on U.S.
Treasury securities at 30-year constant maturity, quoted on investment
basis” go to
http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn
Long-bond Treasury rates are also available from the following
sites:

— http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

–.bloomberg.com/markets/rates/index.html”>http://www.bloomberg.com/markets/rates/index.html
The third alternative is cash. Assume no return on that share of your
monies held in cash.
This analysis
necessarily involves your assessment of systematic risk, i.e., the risk that
affects all industries and companies, in the U.S. economy over the next twelve
months. Let’s more fully define systematic risk. According to the textbook,
systematic risk “…influences a large number of assets, each to a greater or
lesser extent…[and is] sometimes called market
risk…Uncertainties about general economic conditions, such as GDP, interest
rates, or inflation, are examples of systematic risks. These conditions affect
nearly all companies to some degree” (p. 343).
Your task is to consider your investment alternatives in light of systematic
risk expected over the coming year.
Your
considerations about investing in U.S. equities will thus involve your
determination of the near-term prospects for the U.S. economy and the
implications of these prospects for U.S. equities.
A useful site
for recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/.
Click on the highlighted report or “Consensus” next to any particular report to
get data (either recently reported or the near-term consensus, respectively),
the schedule of future data releases, a definition, and, importantly for our
purposes, a section entitled “Why Do Investors Care?” More generally, many other sites provide
information on macroeconomic data, such as:

— .wsj.com/classroom/Indicators/guide.html”>http://info.wsj.com/classroom/Indicators/guide.html
— .bea.gov/”>http://www.bea.gov/

–.gpoaccess.gov/indicators/index.html”>http://www.gpoaccess.gov/indicators/index.html

–.stlouisfed.org/fred2/”>http://research.stlouisfed.org/fred2/

Finally, the
decision to invest in 30-year U.S. T-bonds importantly involves expectations
about future inflation and the term structure of interest rates, i.e., “the relationship between short- and
long-term interest rates” (p. 162). On p. 161 of the textbook the distinction
is made between “real” interest rates and “nominal” interest rates. “Nominal” interest rates are the rates that
are quoted in the financial press; they are the rates at which we borrow and
lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal
rate includes the so-called inflation premium, h, so that the higher the
expected inflation, h, the higher the nominal rate, all else equal. In
considering longer-term T-bonds one must also be aware that, in addition to
expected long-term inflation, there is greater interest rate risk: “…longer
term bonds have much greater risk of loss resulting from changes in interest
rates than do shorter-term bonds” (p. 164). Specifically, should interest rates
increase, the market value of 30-year bonds will fall and the fall will be more
dramatic for a 30-year T-bond than for a 10-year Treasury bond. Conversely,
price gains from any drop in rates will be more dramatic the longer the term to
maturity on a bond. One should also keep in mind that while in general
longer-term rates are typically higher than short-term rates for the same level
of overall risk, there have been occasions when the reverse is true, and the
term structure of interest rates is inverted. (Please see Figure 5.5 on p. 163
on the historical relationship between long-term and short-term U.S. interest
rates.) Finally, in finance we assume that there is no credit or default risk
on Treasury securities. It is assumed that there is no risk that the U.S.
government will fail to meet its outstanding debt obligations. This is, of
course, not the case for corporate issuers.

Finally,
what are the implications of interest rate changes for the equity market? Here
is one response to this question: .investopedia.com/articles/06/interestaffectsmarket.asp”>http://www.investopedia.com/articles/06/interestaffectsmarket.asp
Questions for Individual Asset Allocation Exercise:
3.
Allocate your fictional
$1,000,000 among the following three asset categories:

Asset

U.S. Equities

U.S. 30-Year Treasury Bonds

Cash

Allocation

100%

4.
Justify your allocation based on
your outlook for systematic risk in the U.S. economy over the next year.

[1] For a brief history of the S&P 500 see .cftech.com/BrainBank/FINANCE/SandP500Hist.html”>http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.

[1] Reilly, Frank K., and Keith C. Brown. (2007). An Introduction to
Security Valuation. Equity and Fixed
Income CFA® Program Curriculum·•Volume 5(pp. 115-153). (p. 264).
Boston: CFA Institute.
[2] For a brief history of the S&P 500 see .cftech.com/BrainBank/FINANCE/SandP500Hist.html”>http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.
[3] Source: .markrosa.com/economic_analysis.htm”>http://www.markrosa.com/economic_analysis.htm.
Please note that this site also contains helpful discussions about all three
stages of the top-down approach to security valuation.