Investment Portfolio: Manager for Bob Forsythe Auto - Assignment Example

?Finance 4110 Investment Portfolio The Investor is a 47-year-old married male who is looking to retire at age 67, the first year he is eligible for full social security benefits. He is a district sales manager for Bob Forsythe Auto, a large and highly profitable dealership in mid-Missouri. His earned income, including salary and bonuses, is $85,000 per year. He does receive a cost of living adjustment on an annual basis of 3.5%. His wife works part-time as a freelance photographer; however, her pay is considered supplemental income, as her workflow is not deemed steady enough to cover anything more than the car payments for their two teenage children, ages 17 and 16. Both children also have 529 plans established, gifted to them by their grandparents ten years ago. Therefore, college tuition is not considered a financial objective, as higher education will be essentially paid for through these particular savings plans. Finally, the investor has ten years left on a 30-year mortgage note, thereby paying off the loan ten years before he enters retirement. The monthly mortgage payment is approximately $1125. Since the couple looks at their residence as their dream home, they have no intentions of ever selling their property nor do they intend to purchase a second home. They do not foresee any other significant expenses on the horizon; however, they do have an emergency fund valued at $10,500 to cover any problems that may creep into their financial picture. It can be assumed, then, that their objective will not include constructing an emergency reserve. They can, and will, focus solely on retirement savings. I. Investment Policy: A study conducted by Klein and Iammartino in 2010 states that Modern Portfolio Theory supports the notion that there are three main factors that must be considered when selecting the various investment vehicles that will comprise a sound portfolio: diversification, risk tolerance, and time horizon. In this particular situation, the investor’s age and risk tolerance reflects a need for a moderately conservative approach to building the portfolio. While the investor still has some time on his side for wealth accumulation, stocks traditionally perform rather inconsistently, making it virtually impossible to predict what direction the securities will take on any given day. Of course, most portfolio profits are made by investing in securities, as their sheer nature is to grow money. But like anything in life, there is give and take. While highly lucrative, stocks are also highly volatile, which increases the risk that an investor could lose all money put into a particular security if the company is changing management, losing its competitive edge in the industry, or even worse, headed for insolvency. As times goes on and retirement inches closer, an investor will have less reaction time to deal with any of the above circumstances that are adversely affecting the portfolio’s performance. Consequentially, it makes good financial sense to build in shock absorbers to help alleviate any additional burdens the investor takes by putting money into equities. These absorbers are referred to as fixed income, which is a more secure asset class because these investments pay out through fixed interest rates for a pre-determined time frame and, in some cases, are insured, should the debtor become insolvent. Fixed income is mainly comprised of bonds and CDs. They are not as profitable as equities and can bring their own element of danger simply because more conservative investments typically cannot outpace inflation (think of your investments flying down a freeway with inflation as the highway trooper clocking the speed at which the money is growing). Still yet, they do provide guarantee, which gives the investor peace of mind that the money will never be lost. It can be said then that the aforementioned investor will need to allocate a certain percentage of his money to stocks, bonds, and finally, cash to provide necessitated liquidity in his portfolio, should there be another global downturn in the various sectors of the different markets. Liquidity will allow the investor to sideline the money during tumultuous periods in the market, essentially stopping the hemorrhaging that stocks can trigger when they are in freefall. All of that said, the basic composition of this investor’s portfolio will be reflected in the following chart: It is clear that the majority of his portfolio will need to be allocated to stocks so he can grow his money and achieve his goal of financial independence in retirement. However, a good portion of his investments will be in fixed income so he can have some added protection for his portfolio. It is advantageous to this investor that stocks and bonds do not work in tandem, so that friction may end up saving him from significant losses in an otherwise fragile global economy. The stock class will be comprised of large cap companies that are or are likely to produce a dividend. These entities typically produce dividends due to augmented earnings and solid balance sheets to indicate transparency and solvency. While the investor is comfortable with investing in stock to build his wealth, his risk tolerance will not allow him to take on the more high-risk securities, which are derived from small-cap or start-up companies and various international companies that pose additional political risk, due primarily to the fact that he may invest in a foreign company whose homeland is politically and/or socially unstable. He will benefit more from investments with established, historically profitable organizations. The fixed income section of his portfolio will entail three corporate bonds that are rated high-grade and issued from companies that have positive outlooks moving forward in their respective industries. While the economy is currently experiencing historically low interest rates, it is still recommended to invest in bonds to meet his objective of safety and lower risk. It is highly probable that interest rates will rise over the next five years. Therefore, the maturity of each bond should only be a maximum of five years so he can redeem them and reinvest at higher rates when the economy is a bit more robust and offering more attractive interest rates for investors. He will purchase three bonds, allocated at 10% each to satisfy the 30% of the fixed income portion of his portfolio. According to Moody’s Ratings Agency in 2011, these investment vehicles have the most promising outlook based upon earnings, corporate governance, and solid balance sheets. These bonds have a maturity of five years and are also non-callable, which means that if interest rates took another nosedive, the companies cannot call these bonds in for reissuance at lower rates. This situation is typically good for the company but adverse for the investor. The bonds then will be invested as follows: General Electric, rated AA, yielding 5.23% Goldman Sachs, rated AA-, yielding 5.453% Dow Chemical, rated A, yielding 4.9287% All three bonds are considered investment grade by the ratings agency, as the respective companies have all demonstrated solvency and the potential for future profit surges with the quality of their products. Moreover, they are all considered leaders in their industries, which would indicate that their competitive edges in the marketplace have helped them to secure top positions in terms of earnings history, as well as potential. These bonds will help the investor achieve his objective of an overall portfolio return of 8%, which is satisfactory in these economically unstable times. In addition, the fixed income will give him security and guarantee, two very valuable components for his portfolio. II. Security Analysis: Since the investor is seeking tremendous growth over the next 20 years until his retirement, it is paramount that he invest in equities of companies that are illustrating strong earnings growth, innovative products that are attractive to their consumer bases, and sound balance sheets that indicate both transparency and profitability. He is taking a gamble by structuring the majority of his portfolio with stock; however, the only true way to grow his money is to invest in securities. Still yet, he will assume a lot more risk with these particular investments, which reaffirms the notion that all companies in which he invests will need to either produce a dividend or indicate that they will produce a dividend. According Morningstar in 2011, there are companies that are currently undervalued, but are demonstrating strong earnings potential, which will bode well for the investor. He will be able to purchase stock at discount prices and reap the financial rewards because he invested in high quality stocks that are on the rise and are likely to produce dividends. In other words, he will get the most bang for his buck. Therefore, the equity portion of his portfolio will be invested in the following companies: 3M (MMM) is a diversified industrials company that manufactures everything from post-it notes to large office equipment. They provide a need to not only the business community but also to households that use their products for personal reasons. The company’s dividend yield is 2.42% with an EPS of 5.66. Their ROE is 29.37%, which indicates that their economic moats are expansive, thereby extending profitability for the foreseeable future. Abbott Laboratories (ABT) is a major drug manufacturer. The pharmaceutical sector of the market is typically robust, as it is intimately linked with healthcare, which is a universal matter that expands the globe and affects every major economy. Abbott’s current dividend yield is 3.60%, with an EPS of 3.05. However, their revenue growth has been strong, as it is currently at 11.03% over a three-year period. Finally, their ROE is 22.11%, making this stock incredibly attractive because of its affordability and earnings potential moving forward. Colgate-Palmolive Company (CL) is in the household and personal products sector. This particular portion of the market also performs well, as they manufacture products to service basic human needs for daily living, such as toiletries, household cleaners, and the like. Currently, Colgate-Palmolive is experiencing historically high earnings but the with an ever-fragile economy, their stock is undervalued. This may end up being one of the investor’s best buys, as they are currently yielding dividends of 2.54%, with an EPS of 4.28 and an ROE of 83.49%. They are surging and look to have a promising outlook, as their competitive edge is durable and their balance sheets are solid. Paychex, Inc. (PAYX) is housed in the staffing and outsourcing services industry. This particular sector is also on the rise, as a whole, in the market. Due to a high unemployment rate that is hanging at 9.5%, this industry is experiencing an influx of investors, as outsourcing companies’ primary function is to fill employment with displaced workers who have experienced layoffs or even termination. Furthermore, even as this can be attractive for investors, Paychex is showing that their issued stock is outperforming their industry peers with strong growth and earnings clinging to 1.36, that will change and more than likely increase, as their ROE is 34.72%. This company is moving at lightning speed and this is demonstrated by solid company data that supports the notion that they are on the rise. PepsiCo, Inc. (PEP) is located in the packaged foods sector of the market. They are literally a household name, as they manufacture Pepsi soft drinks; however, they also own and operate Frito Lay, as well as various fast food chains like Taco Bell and KFC. With their assortment of product lines that have universal appeal, they are on track to remain a staple in their respective industry. This company is currently producing a dividend of 2.87%, with an EPS of 3.97 and an ROE of 36.35%. It’s true that dividends are historically low right now for this particular company. Still yet, their sturdy competitive edge will continue to fatten their profit margins, as people on the go will always consume more convenient sustenance, such as snack foods and fast food. Wal-Mart Stores, Inc. (WMT) is placed in the discount stores industry and is a global symbol for quality items at deep discounts prices. Wal-Mart also provides products that will meet basic human needs, such as toiletries. However, they also offer a virtual one-stop shop for their consumer base, as they have automotive, toy, and grocery lines, just to name a few. It is true that they have experienced recent legal troubles with various employees who claim sex discrimination. On the other hand, according to CBS News in 2011, the courts have dismissed the case, citing baseless allegations. This is highly advantageous to both the company and current or potential investors, as concerns that the company may have to settle with the plaintiffs have quickly diminished. In other words, Wal-Mart may keep its money to dole out to their investors, as their earnings potential remains strong. Currently, they are yielding a dividend of 2.22%. Their revenue growth is robust, hanging on to 5.43%, with an EPS of 4.03 and an ROE of 22.60%. Finally, the investor will round out his portfolio with 10% in cash and cash alternatives. This portion will be comprised of cash, money markets, and the like. This provides the necessary liquidity, should he need to either access the money to meet an unforeseen expense or sideline it during significant downturns in the economy, thus triggering the market prices to fall. It’s additional security for his portfolio, in addition to the fixed income built into his investments. This will satisfy his appetite for lower risk investment vehicles while providing the opportunity to build his wealth and achieve his objective of financial independence in retirement. Once the investor has reached retirement, it would behoove him to flip the allocation of equity and fixed income, as his portfolio objective will transition from growth to capital protection. Therefore, his portfolio would need to be revised to include 60% fixed income and 30% equity. He will still necessitate stocks for growth, careful not to allow himself to outlive his money. In other words, he’ll need to hang on to his money and invest the majority of his funds in safe, secure bonds that will provide guarantee. References CBS News (June 2011). High court dismisses Wal-Mart lawsuit. Retrieved from http://www.cbsnews.com. Klein, Peter, J. and Iammartino, Brian, R. (2010). Getting Started in Security Analysis. 2nd ed., 57-73. Moody’s Ratings Agency. 2011. Retrieved from http://www.moodys.com. Morningstar. 2011. Retrieved from htt://www.morningstar.com. Read More