OPTIMUM PORTFOLIO: An Empirical Analysis Submitted By: Neha Dhingra Enroll No. -07BS2482 ICFAI Business School, Bangalore OPTIMUM PORTFOLIO: An Empirical Analysis Submitted By: Neha Dhingra 07BS2482 A report submitted in partial fulfillment of the Requirements of MBA Program of ICFAI Business School, Bangalore Faculty Guide: Company Guide: Prof. Ashish Dash Ms. Rangapriya.
S Faculty Financial Analyst ICFAI Business School Right Horizons Bangalore Bangalore Contents ABSTRACT6 EXECUTIVE SUMMARY7 ACKNOWLEDGEMENTS11 CHAPTER 1: OVERVIEW12 MOTIVATION13 LITRATURE REVIEW14 OBJECTIVE19 SCOPE OF THE STUDY20 EMPIRICAL FRAMEWORK21 DATABASE23 TIME FRAME26 CHAPTER SCHEME26 CHAPTER TWO: SECTORAL ANALYSIS27 2.
1 AUTOMOBILE SECTOR28 2. 2 TELECOMMUNICATIONS30 2. 3 BANKING SECTOR34
CHAPTER THREE: FUNDAMENTAL ANALYSIS38 COMPANY ANALYSIS40 CHAPTER FOUR: OPTIMAL PORTFOLIO CONSTRUCTION AND CORRELTION ANALYSIS63 OPTIMAL PORTFOLIO64 OBSERVED PORTFOLIO67 CHAPTER FIVE: CONCLUSION70 CONCLUSION71 REFERENCES:74 APPENDIX I: Company description76 APPENDIX II: Explains the financial ratios considered for the purpose of company analysis. 79 List of Tables |Table 1. 1 |Reviews the literatures that have been studied for the purpose of this study. | |Table 1. 2 |Lists various information available and unavailable in each of the databases used for the purpose of | | |this study.
|Table 1. 3 |Displays the various stages and the dates of evaluations. | |Table 2. 1 |Shows the respective shares of foreign as well as Public Sector Banks in terms of branches, staff, | | |deposits, advances and net profit | |Table 3. 1 |Lists the values of the various ratios used for analyzing the fundamentals | |Table 4. 1 |Lists the percentage allocation to each of these securities in the optimum portfolio. | |Table 4. |Lists the percentage allocation to each of these securities in portfolio of Reliance Growth mutual fund| | |as on 31st March 2008. | List of Figures |Figure 2. 1 |Shows the categorization of various producers on the basis of products produced by them in | | |Automobiles Sector | |Figure 2. 2 |Market Shares of Telecom Service Providers | |Figure 3. 1 |Shows the various financial ratios that form the company fundamentals. | |Figure 4. |Portrays the allocation in the Optimal and Observed Portfolio to various sectors. | ABSTRACT This project explains how theory can serve as an instrument to analyze the fundamentals of thirty five companies before recommending them as an investment avenue. It discusses how to construct an optimal portfolio making use of modern portfolio theory and thereby concluding that their exists very less correlation between the observed portfolio of a mutual fund and an optimal portfolio thereby proving that this well performing fund do not use theories rather the experience of fund managers which makes them yield good returns.
EXECUTIVE SUMMARY Name: Neha Dhingra Enrollment No. :07BS2482 Company Description: Right Horizons( www. righthorizons. com ) is an end to end investment advisory and wealth management firm that focuses on providing a solution that is specific to customer needs like corporate treasury management, Tax planning, corpus fund planning etc. Title of the project: The study titled “Optimum Portfolio: An Empirical Analysis” is carried out during 22nd February 2008 to 22nd May 2008 at Right Horizons Financial Services Pvt.
Ltd. Objectives of the project: Following are the objectives for this study: ? To understand and analyze key sectors such as Automobiles, Telecommunication and Banking sectors for considering equity investments. ? To identify companies within these sectors as well the ones comprising portfolio of Reliance Growth mutual fund and conduct a Fundamental Analysis on these equities. ? To construct an optimal portfolio, that includes the selected shares of the sectors as well as shares comprising portfolio of Reliance Growth mutual fund. To compare the observed portfolio of a top performing mutual fund with the optimal portfolio. Background: Portfolio Management is one of the most important aspects of financial services. It aims at minimizing the risk of an investor and at the same time it attempts to maximize the returns. This study is an attempt to search out existing theoretical and empirical knowledge in the area of portfolio management and further devise strategies to design an optimally diversified portfolio. Methodology used:
The study analyzes several key sectors such as Banking, Telecommunications and Automobiles Further, an attempt is made to analyze thirty five companies from the portfolio of Reliance Growth mutual fund (which is a well performing mutual fund) operating in Indian equity market by using various financial ratios. It then constructs an optimal portfolio using the empirical framework developed by Elton Gruber and Pedberg. Further, the performance of the observed portfolio of Reliance growth and that of the optimal portfolio constructed in this study are compared. Findings and conclusion:
The study concludes that there is a very low correlation of . 0939 between Reliance growth mutual fund and that of the optimal portfolio constructed in this study. The expected returns are calculated for the optimal portfolio which yields 47. 83 percent per year which is slightly lower than returns yielded by the observed portfolio of Reliance growth i. e. 52. 35 percent per year calculated on the basis of average monthly returns over the period March 2005 to March 2008. However, this higher return could be attributed to the higher risk thsat is taken in the construction of the portfolio of Reliance growth.
The study finds that though the observed portfolio (of Reliance growth) is yielding higher returns at the same time it is exposed to higher risk. Special Achievements & Recognitions: • The Investment suggestions that are made out of the findings and initial observations of this study are implemented for various high end Clients. These suggestions included: ? Recommendations were given during the market correction of March 2008 to various high end clients for switching from debt to equity mutual funds. Identifying and communicating investment ideas relating to mutual funds ( NFOs) and equities to clients for consideration of Investment. • Recognized for good performance and hard work related to the organization. • Recognized for choosing appropriate candidates for recruitment of financial analyst and marketing executives. • Personal satisfaction and confidence towards successfully integrating Standard Portfolio theory and financial ratio analysis in investment decision making for high end clients. Exposure to databases like Prowess, Capital Line has further the enriched the learning experience of undertaking this study. ACKNOWLEDGEMENTS I would like to thank Right Horizons Financial Services Pvt Ltd. And especially for Ms. Rangapriya. S for giving me an opportunity to do my internship with such an esteemed organization and providing me with help and guidance in completing my study and provided me with an opportunity to learn insights into the Financial Services Industry and gave me an exposure across domains so that I can learn every aspect of management.
I would also like to thank Prof. T. R. Venkatesh, Director of ICFAI Business School for his words of encouragement and Prof. Ashish Dash, my Faculty guide for his guidance, support, special training and the time he committed to enhance the learning during the course of this project and his help at every stage of project completion. Also, I would like to thank the Placement team IBS Bangalore and Ms. Sharon Jose, SIP coordinator for supporting me to get a suitable project for pursuing my internship with an organization that has enhanced my learning’s. | | Chapter 1: OVERVIEW | | (This chapter discusses the basic motivation behind the study and the initial | |thought process when this study was undertaken describing each and every step taken| |to achieve the goals. ) | MOTIVATION Portfolio Management is one of the most important aspects of financial services.
It aims at minimizing the risk of an investor and at the same time it attempts to maximize the returns. To start with several researchable questions occur to one’s mind in the context of portfolio management like the ones listed below: • What are the various intricacies involved in making investment decision in favor of a particular stock? • How risk can be managed while investing in equities? • What are the alternative criteria for making investment decision in a stock? • What criterions financial companies consider while making investment recommendation in favor of a particular stock to their clients? Do historically well performing mutual funds also invest in similar equities? If so to what extent. • To what extent optimal portfolio is correlated with the observed portfolio of well performing Mutual funds? • Whether Mutual funds that are closely related to optimal portfolio have performed well in terms of historical returns? The real motivating factor behind this study is to find plausible answers for the questions raised above. While the present Summer Internship Program at ‘Right Horizons Financial Services Pvt. Ltd. will certainly give a practical exposure to the art of security analysis and the craft of Investment decision making (among others), an added attempt is undertaken to search out existing theoretical and empirical knowledge in the area of portfolio management and review the same to formulate a set of objectives for this study. LITRATURE REVIEW: While seminal works such as Sharpe et al (1994), Elton et al (1996), Fisher et al provides an excellent review of theoretical aspects of portfolio diversification and investment decisions, the following table summarizes the theoretical and empirical review of related studies.
Table 1. 1: Reviews the literatures that have been studied for the purpose of this study. |Title |Author |Date |Remarks | |Modern Portfolio Theory and |Edwin J. Elton et al |1996 |This book deals with the economics behind designing a| |Investment Analysis | | |portfolio as well as theories regarding portfolio | | | | |optimization. |Investments |William F. Sharpe et al |2007 |This book deals with art of buying and selling | | | | |securities as well as security markets. Also, it | | | | |explains the Modern Portfolio theory of Elton et al | | | | |and Sharpe ratio as an art of designing portfolios | |Security Analysis and Portfolio |Donald E.
Fisher et al |1995 |This book portrays the art of Industry and Company | |Management | | |analysis and the basics of designing a portfolio by | | | | |selecting stocks from the securities market. |“Constructing an optimal |Debashish Dutt |2002 |This paper has constructed an optimal portfolio using| |portfolio using Sharpe’s single | | |the Sharpe’s Model taking BSE 100 as the market index| |index model” | | |but it has not made use of adjusted share price data | | | | |which has affected the outcome to a large extent the | | | | |portfolio is biased towards Banking stocks with the | | | | |complete 100 per cent of the corpus invested in | | | | |banking stocks which will be faced with volatility as| | | | |and when any changes in banking sector comes in | | | | |operation. |“Return Forecasts and Optimal |Lingjie ma et al |2007 |This paper uses the quantile regression model in | |Portfolio Construction: a | | |financial markets and proposes models for return | |Quantile Regression Approach” | | |forecasting and portfolio construction. This study | | | | |concludes that the Quantile Regression method is more| | | | |useful than classical conditional mean method. | |R2: A Market-Based Measure of |John E.
Cresson |2000 |This study evaluates [pic]as a valid measure of | |Portfolio and Mutual Fund | | |portfolio and mutual fund diversification and it | |Diversification | | |provides evidence of diversified portfolios and | | | | |diversified mutual funds having significantly higher | | | | |[pic]than undiversified portfolios and undiversified | | | | |mutual funds. |Modern Portfolio Theory(MPT) and |Gregory Curtis |2002 |This article examines selected limits to the | |Quantum Mechanics | | |usefulness of MPT and through critical examination of| | | | |the assumptions underlying, draws conclusions how MPT| | | | |can provide helpful insights to investors. It | | | | |attempts to classify various asset classes, the role | | | | |and use of hedge funds, real estate, or hard assets. | | | |In conclusion, This study recommends employability of| | | | |MPT concepts in financial advisory area. | |The Impact of Mutual Fund Family |Elton et al |New York University, |This paper discusses how investors who confine their | |Membership on Investor Risk | |May 2004 |mutual fund holdings to a single fund family, tend to| | | | |restrict their returns exposing their portfolio to | | | | |much higher risk.
As, empirical evidence shows that | | | | |degree of correlation between two similar category | | | | |funds of similar mutual fund family is much higher as| | | | |compared to two funds in same category but different | | | | |fund families. | These literatures have also helped in understanding the empirical framework which could be used for the construction of optimal portfolio. Further base on the above literature review the following objectives are set out for this study. OBJECTIVE: Following are the objectives for the study: 1.
To understand and analyze Automobiles, Telecommunication and Banking sectors  for consideration of equity investment. 2. To identify companies within these sectors as well the ones comprising portfolio of Reliance Growth mutual fund  and conduct a Fundamental Analysis on these equities. 3. To construct an optimal portfolio, that includes the selected shares of the sectors as well as shares comprising portfolio of Reliance Growth mutual fund. 4. To compare the observed portfolio of a top performing mutual fund with the optimal portfolio. SCOPE OF THE STUDY: The scope of the present study in terms of portfolio diversification is restricted to India.
Further, the asset class that has been considered is restricted to Indian equity market and more specifically national stock exchange of India (NSE). EMPIRICAL FRAMEWORK: 1. An Analysis of the sectors would be undertaken to identify stocks that are among the top performers in their respective sectors. In doing so the study will focus on various financial ratios such as Price/Earnings ratio, Book value per share, Earnings per share, Interest Coverage ratio, Debt equity ratio to mention a few. 2. The Mutual fund that is performing well would be identified using historical performance and the allocation of funds in these mutual funds would be examined. 3.
An optimal portfolio would be developed in line with Elton et al (1981) where the identified shares from the above analysis would be included. The steps for the construction of an optimal portfolio in line with Elton et al, as provided in Sharp et al (1995) are as follows: i. Compute the return on various securities and the market return. ii. Calculate the excess return-to-beta ratio for each stock under consideration and rank them from highest to lowest order. [pic] Where, R[pic]—- The expected return on stock i R[pic]—- The return on a riskless asset [pic]—- The expected change in the rate of return on stock I associated with a 1 per cent change in market return. iii. Find out [pic] by using the formulae: [pic] Where, [pic] iv.
The optimal Portfolio consists of investing in all stocks for which excess return over beta is greater that a particular cut-off point C. v. Once the cut-off rate is determined, we know which security will figure in the optimal portfolio. The next step is to calculate the proportion to be invested in each security. The proportion to be invested in each security is: [pic] Where, [pic] 4. Finally this optimal portfolio would be compared with that of the mutual funds. DATABASE: The Databases for the present study are secondary in nature. Table 1 provides information relating to the secondary databases useful in the context of present study. Table 1. : Lists various information’s available an not available in each of these databases |Data |URL |Data collected |Limitations(If any) | |Companies Data |www. moneycontrol. com |Share prices |Adjusted share price data not| | | | |available | | |Prowess Database |Share prices & ratios |– | | |www. nseindia. om |Indices |Adjusted share price data not| | | | |available | |Mutual Fund |www. moneycontrol. com |Portfolio’s |– | | |www. valueresearchonline. com |Portfolio’s |Only top five allocations are| | | | |available | |Sectoral Data |www. trai. gov. n |Telecom Industry |– | | |Economic Survey of India 07-08 |Sectoral Productions |– | | |Union Budget 2008-09 |Changes in Taxes and excise duties|– | | |Finance Ministry of India |Indian Economy in Comparison with |– | | | |ROW | | | |acmainfo. com |Auto ancillary Industry |– | |Research |www. ssrn. com |Journals |– | | |Search. ebscohost. com |Journals |– | Source: Compiled by the author The time period is 2006-2008 for which various information have been collected. TIME FRAME: Table 1. 3: Displays the various stages and the dates of evaluations. Evaluation Stage |Date |Activity | |Stage- I |24th – 29th March, 2008 |Project Proposal | |Stage- II |21st – 26th April, 2008 |Project Interim Evaluation | |Stage- III |19th – 24th May, 2008 |Project Final Evaluation | |Stage- IV |19th – 24th May, 2008 |Project Specific Evaluation | Source: Student Hand book, SIP, 2008 CHAPTER SCHEME: The next chapter focuses on the analysis of Automobiles, Telecommunications, and Banking sectors. Chapter three provides the Fundamental analysis of thirty five securities that have been selected on the basis of the securities comprising the portfolio of Reliance Growth mutual fund as on 31 March 2008. Chapter four attempts to construct an optimal portfolio and compare the same with that of observed portfolio of the mutual fund. Chapter five summarizes the main findings of the study and concludes. | |Chapter two: | |SECTORAL ANALYSIS | |(This chapter aims at analyzing three sectors namely Automobiles, Banking and Telecommunications. | |This would help in understanding the sectoral growth and performance which in turn would be | |useful for making investment decisions in the equities of these sectors. ) | 2. 1 AUTOMOBILE SECTOR: Production of automotive industry which provides extensive forward and backward linkages to other key segments of the economy is growing at an impressive rate.
However, as the Indian Industrial Production (IIP) data suggest, their production growth has been negative during April-November 2007. But, the turnover of the fast growing auto component industry, comprising around 500 firms in the organized sector and more than 10,000 firms in the small and unorganized sector, grew from US$ 3. 1 billion to US$ 15 billion between 1997-98 and 2006-07. The quality standards have also improved which is evident from the International recognition as well as the expanding exports which grew at a compound annual growth rate of 29. 07 per cent to reach US$ 2. 9 billion while imports grew by 31 per cent to reach US$ 3. 33 billion.
Though, India is a net importer of auto components in the current liberalized duty regime, the challenges faced by the industry is to innovate and upgrade continuously to remain competitive in the international market and strive to increase its market share from current 0. 4 per cent share of the global Auto Components Industry. Indian government has also finalized the Automotive Mission Plan (AMP) 2006-16 for making India a preferred destination for design and manufacture of automobiles and automotive components. Figure 2. 1: Shows the categorization of various producers on the basis of products produced by them [pic](Source: Overview of the automotive component sector in India, April 2007 – The Indo-Italian Chamber of Commerce and Industry)
The Auto Component Industry is graduating to World- class by substantially increasing investments in production capacities and by establishing partnerships in India and abroad, investing in or acquiring companies overseas. Budget 2008-09: • Customs duty reduced on steel melting scrap and aluminum scrap from 5 per cent to nil. • Excise duty reduced on buses and their chassis from 16 per cent to 12 per cent. • Excise duty reduced on small cars from 16 per cent to 12 per cent and on hybrid cars from 24 per cent to the general revised rate of 14 per cent. • Excise duty reduced on two wheelers and three wheelers from 16 per cent to12 per cent. Impact on sector: Customs duty nullified on select metal scrap might reduce the raw material cost for some of the auto component players • Excise duty reduction in select auto segments will help spur demand for automobiles, which in turn will benefit the components industry. 2. 2 TELECOMMUNICATIONS: With more than 270 million connections, India’s telecommunication network is the third largest in the world and the second largest among the emerging economies of Asia. The telecom sector continued to register significant growth during the year 2007 and has emerged as one of the key sectors contributing to the Indian economic growth. This has been possible due to the supportive Government policies coupled with the private sector initiative.
The focus of the policy has been on network expansion, rural telephony, broadband coverage and R&D and on providing an enabling environment for the competitive growth of the sector. Opening of the sector has created an impressive forward momentum in India resulting in massive investment and expansion with technological changes and improvement in quality of the telecom services. The liberalization efforts of the Government are evident in the growing share of private sector in total telephone connections, which has increased from 39. 2 per cent in 2004 to 72. 4 percent in December 2007. The growth of wireless services, in particular, has been phenomenal, with number of wireless subscribers growing at a compound annual growth rate (CAGR) of 87. 7 percent per annum since 2003.
Today, the wireless subscribers are not only much more than the fixed subscribers in the country, but also increasing at a much faster pace. The share of wireless phones has increased from 24. 3 per cent in March 2003 to 85. 6 per cent in December 2007. Improved affordability of wireless phone has made the universal access objective more feasible. The Universal Service Obligation Fund (USFO) continues to be used to subsidize the developments in the telecom sector in the rural areas. Figure 2. 1: Market Shares of Telecom Service Providers: [pic] (Source: The Indian Telecom Services Performance Indicators July– September 2007. TRAI) Budget 2008-09 • Specified inputs and raw materials for manufacture of specified electronics/ IT hardware items have been exempted from excise duty. Additional duty of 1 per cent to be levied on imported mobile phones towards national calamity contingency reserve. • Countervailing duty on wireless data modem cards with exempted by way of excise duty exemption. These goods are already exempt from customs duty. However, 4 per cent additional duty of customs will be attracted. • Internet telecommunication service brought under the service tax net. • Customs duty on convergence products to be reduced from 10 per cent to 5 per cent. Impact on Sector: • Exemption from excise duty for specified inputs and raw materials for manufacture of specified electronics/ IT hardware to lower the network cost for telecom service providers. • Additional duty on imported mobile hones to make handsets expensive, thus prohibiting a faster acceptance. • Imposition of service tax on Internet telecommunication services to make them expensive. • Reduction in customs duty on convergence products to help establish parity between devices used in the information/communication sector and the entertainment sector. 2. 3 BANKING SECTOR: With the Indian economy developing and incomes rising even though standard of living is rising there has been a trend of increasing Investment in the economy. So, the Indian banking sector is at a turning point towards growth. Further, as Indian companies are globalizing, several Indian banks are pursuing global strategies in order to compete with Foreign Banks.
There are in totality 222 commercial banks in India (of which 133 RRBs) with nearly 70% of branches in rural/semi-urban areas. The ratio of assets of commercial banks to GDP has increased to 92. 5 per cent at end-March 2007. Consequently, the degree of leverage enjoyed by the banking system, as reflected in the equity multiplier has increased by 3. 9 percent at the end of March 2007. Foreign banks will have the opportunity to own up to 74 per cent of Indian private sector banks and 20 per cent of government owned banks. These foreign banks with huge capital reserves, cutting edge technology, best international practices and skilled personnel will create a major competitive challenge for Indian banks, especially the public sector banks.
Banks are supporting growth in the economy by financing productive sectors with bulk of commercial bank financing for short-term working capital needs of industry, trade, agriculture & personal segment. Credit – Deposit ratio (CD Ratio) increased to 72. 5% against benchmark 60% reflecting the strong underlying credit momentum. Table 2. 2: Shows the respective shares of foreign as well as Public Sector Banks in terms of branches, staff, deposits, advances and net profit | |Branches |Staff |Deposits |Advances |Net Profit | | |% age share in total | |Public Sector Branches |88. 41 |87. 3 |75. 24 |73. 25 |73. 62 | |Private Sector Branches |11. 33 |10. 76 |19. 42 |20. 24 |16. 95 | |Foreign Banks |0. 26 |2. 01 |5. 44 |6. 51 |9. 43 | |ASCB Total Banks |100 |100 |100 |100 |100 | (Source: Indian Banking: Shaping an Economic Powerhouse, Sh. T. S. Bhattarachya, M. D. SBI, 2006) Budget 2008-09: • Initial provision of Rs 1,600 crore made for interest subvention in 2008-09. PSU banks and regional rural banks (RRBs) to offer debt waiver on all agricultural loans disbursed up to March 2007 and due until the end of December 2007. • Complete debt waiver on all loans given to small and marginal farmers. • The total value of relief to be offered to farmers is estimated at Rs 60,000 crore. • The government has advised PSU banks and RRBs to add at least 250 rural household accounts every year at each of their rural and semi-urban branches. • Public sector banks have been asked to include Indira Awas Yojana (IAY) houses under the differential rate of interest (DRI) scheme and lend up to Rs 20,000 per unit at annual interest rate of 4 per cent. • Banking Cash Transaction Tax (BCTT) being withdrawn with effect from April 1, 2009. Impact on sector: PSU banks are expected to face pressure on their net interest margins until the subsidy for waiver of agricultural loans and one time settlement of loans is released from the government. • The cost of adding more rural households in their rural branches may increase the operating cost for the PSU banks. • Including Indira Awas Yojana (IAY) houses under the differential rate of interest scheme at an interest rate of 4 per cent will increase the proportion of sub-PLR lending for the PSU banks. Taking the above developments into consideration, ever since Indian economy opened its doors to MNCs, the Indian banking sector has been witnessing bizarre changes in terms of new products and services and stiff competition as well. The sorts of IPOs that have been taking place in banking sector are amazing.
In the light of these recent developments, a careful analysis of the profitability of Indian banking sector is inevitable. The present study attempts to analyze the profitability of the two major banks in India: SBI and HDFC one of which is a public sector undertaking and other a private sector venture. Conclusion: Therefore this chapter has determined the basic outlining features of these sectors so that the investment decisions can be undertaken can be undertaken keeping in view the research conducted on the basic fundamentals, the growth achieved by each of these sectors in the past as well as the future prospects projected on the basis of Union Budget 2008-09 which has impacted each of these sectors in an entirely different way. | |Chapter three: | |Fundamental Analysis | |(This chapter intends to understand the fundamentals of the selected companies using financial| |ratio analysis to consider these companies for investment purpose. ) | Fundamental Analysis: The thirty five companies selected from the portfolio of Reliance Growth’s growth plan. These companies includes various sectors namely Automobiles, Banking, Breweries, Chemicals, Construction, diversified, electrical equipments, Energy, Information technology, Media, Mining, Oil drilling, Petrochemicals, Pharmaceuticals, Shipping, Steel, Power, Telecommunication and Trading. Ratio analysis of these companies will be undertaken considering following ratios: Figure 3. 1: Shows the various financial ratios that form the company fundamentals. [pic]
Compiled by the author Company Analysis: Table 3. 1: Lists the values of the various ratios used for analyzing the fundamentals [pic] Bharti Airtel: [pic] Performance in FY07: Profitability aspects this company is yielding very good returns to its shareholders with a ROCE of 46. 01 per cent, Earnings per share equal to 21. 17 and a PE of 36. 08x. The earnings are yielding a return of 5. 35 per cent to the market capitalization of this company at FY end. The company has a policy of reinvesting its earnings into its operations. But, from the aspect of riskiness as the current ratio for this company is very low i. e. 0. 35 which implies it has 0. 5 units of current assets to pay of 1 unit of its current liabilities which may act as a source of financial risk to the company. On the other hand the ICR of the company is appropriate as it has 0. 46 units of dent for every one unit of equity in its capital structure. Reliance Telecommunications: [pic] Performance in FY07: From the aspect of profitability it is giving less return on the employed capital as compared to its peer Bharti Airtel of 11. 57 per cent with an EPS of Rs. 35. 37 and an earnings yield of 5. 49 per cent. It is also giving very low dividends of Rs. 0. 50/share with a yield of 0. 12 per cent on its market price as on 31 Dec 07. It is paying out 4. 0 per cent of its earnings as dividend and the rest 95. 80 per cent is being ploughed back into its operations. But, from the aspect of riskiness it is considered to be more risky than Bharti airtel with a lower current ratio of 0. 34 and quick ratio of 0. 08. Since its utilizing more debt in its capital i. e. 0. 71 units of debt for every one unit of equity, its ICR is at a safe level of 6. 32 per cent. Therefore, it can be concluded that comparing the two companies comprising the portfolio, Bharti Airtel is considered to be yielding High return with high risk, and Reliance Communications is yielding lower returns with higher risk. Bank of Baroda: [pic] Performance in FY07
The bank has been able to improve business performance, achieving record business growth; significantly improving asset quality & reducing NPA levels which can be determined with the return on capital employed equal to 51. 52 per cent and a PE of 7. 63x. Even though it has yielded the highest yield on earnings out of the thirty five companies yielding returns on dividend of 2. 79 per cent. Taking the risk aspects it is not in a very safe position with the interest coverage ratio of 1. 3 per cent; it is not in a position to take up more debt in its capital even though it has a very low DE ratio of 0. 45. HDFC Bank: [pic] Performance in FY 07 HDFC Bank is considered to be a risky investment with a very low on all ratios except current ratio.
But, it is giving good returns with a ROCE of 47. 57 percent and EPS 0f Rs. 35. 74 and a PE of 26. 7, it is considered to be a security with high risk high return yielding capacity and can be strongly considered for the aggressive portion of a portfolio. State Bank of India: [pic] Performance in FY07 SBI has yielded returns of 60. 69 percent on its earnings and 1. 49 percent on the dividend paid. With a PE of 11. 67x it definitely seems to be a strong option for investment in the blue chip companies. Considering the risk aspects, it has a very low interest coverage ratio of 1. 32 per cent and with very high debt equity ratio of 1. 79, it may expose the bank to very high risk levels.
Therefore, it can be concluded that HDFC Bank is considered as possessing the strongest fundamentals followed by SBI which has a strong backing from government of India and lastly Bank of Baroda as it is still in the phase of modernization and will take time to reach at the levels of operation of other two banks. Radico Khaitan Limited: [pic] Performance in FY07 The company has given less than average returns in last FY with a yield on its earnings of 7. 10 percent and the lowest EPS in the whole group of Rs. 3. 37. From the aspect of riskiness even though it has current ratio at adequate levels it has a very high concentration of debt in its portfolio i. e. 2. 73 units of debt for every one unit of equity which can be analyzed from the low levels of ICR.
But, it can be considered for the purpose of diversification across sectors. United Phosphorous: [pic] Performance in FY07 UPL is considered to be a safe investment with current ratio at appropriate level but it has a high debt-equity ratio of 1. 76. This company can be considered to be an overpriced security by a PE of 66. 78 but it is yielding low returns of 6. 17 percent as it is not paying out any dividends also, but it can be considered for investment due to the growth prospects in the chemicals sector. Adani Enterprises Limited: [pic] Performance in FY07 Adani enterprises have yielded good returns on the capital employed in the company i. e. 24. 72 percent. But considering the PE ratio 34. 1x it seems to be an overpriced share as the earnings are not justified by the price demanded by the security which is proved by a low yield on its dividend i. e. 0. 21 percent even though it has a very high proportion of debt in its capital structure it is not able to give adequate returns to its ordinary shareholders. Jai Prakash Associates: [pic] Performance in FY07 Jaypee Group is an accredited brand in the construction domain and it has also performed well in the last FY giving dividends yield to the extent of 3. 34 percent and an EPS of Rs. 18. 93. On the aspect of riskiness also it is considered to have moderate levels of risk with an exception towards Quick ratio which is much lower than acceptable levels.
Therefore it can be considered to be a more than average returns and moderate level of risk exposed company. Madhucon Projects: [pic] Performance in FY07 Madhucon project can be considered to be yielding average returns with average level of risk which can be seen by ICR, Current ratio and Dent Equity ratio at adequate levels except Quick ratio which is low and can expose the company to higher risk. Also, it has yielded average returns to its shareholders with an EPS of Rs. 11. 30 and a dividend payout ratio of 5. 31 per cent it has paid a dividend of 60 paisa per share as dividends. Therefore it can be concluded that in the domain of construction Jai Prakash associates can be considered as a better avenue for investment than Madhucon Projects.
But, keeping in view the growth potential in Infrastructure sector especially in a growing economy like India, construction sector is projected to yield good returns. Greaves Cotton Limited: [pic] Performance in FY07 With an ICR of 10. 84 and debt-equity ratio of 0. 25 graves cotton seems to be performing lower than average on risk aspects and yielding ROCE of 51. 38 percent and an EPS of Rs. 15. 48, it yielding a returns on dividends of 2. 20 percent. Even though it is exposed to less financial risk, it is exposed to a high degree of business risk because of the intensive competition in this sector especially in an open economy like ours. Orient Paper and Industries: [pic] Performance in FY07 OPIL is yielding the highest ROCE in all the selected companies of 53. 1 percent and the lowest PE of 5x.
Also, it is yielding the highest returns on its dividends of 24. 37 percent. The company is also exposed to less risk in terms of the Current ratio, ICR. But, the company has a large amount of debt in its capital of 2. 01 units for every one unit of equity which may act as a matter of concern for its future growth prospects. Reliance Industries Limited: [pic] Performance in FY07 The company has yielded very high returns in FY07 with EPS of Rs. 78. 28 and a ROCE of 22 percent. Even though it is considered to be risky investment considering the Quick and Current ratios but the returns have justified the risk taken by an investor in expectations of higher returns.
Therefore, RIL can be considered for the aggressive portion of the portfolio as this company has a backing of Reliance group and it is expected to yield good returns even in the future especially with its presence across sectors. Crompton Greaves Limited: [pic] Performance in FY07 With a PE of 38. 02x it has yielded a ROCE of 40. 25 percent, it can be considered to be a less than average risk and more than average returns. This company can definitely be considered for the moderate part of portfolio as electricity generation is one arena where the economy is less open and thereby exposed to less competition and thereby is exposed to less business risk. Reliance Energy: [pic] Performance in FY07 Reliance Energy yielded EPS of Rs. 32. 83 per share with a dividend payout ratio of 16. 14 percent yielding returns on its dividends of 1. 07 percent.
From the aspect of riskiness it can be considered to be exposed to average level of riskiness with a high ICR and low debt equity ratio 0. 68 and current and quick ratio in a moderate position. AIA Engineering Limited: [pic] Performance in FY07 The company can be considered to be exposed to very high risk since all the current assets held by the company are in the form of inventory which is not as liquid as any other current asset thereby not able to support the financials at a stage of crisis except that it is yielding enough profits to bear the interest cost as can be observed by the ICR of 70. 17 per cent. But, since it is yielding good returns to its shareholders with an EPS of Rs. 35. 60, it seems to be attractive trading at a PE of 33. 2x. BEML India: [pic] Performance in FY07 The company has a backing by the GOI and is yielding good returns observed by EPS of Rs. 55. 77 and ROCE of 33. 97 percent. The company’s earnings are justified as it is not paying out any dividends to its shareholders instead it is investing it back into the company’s operations. With a very low Debt Equity ratio, it is considered to be Good Avenue for investment. Gujarat State Fertilizers & Chemicals Ltd: [pic] Performance in FY07 The company is yielding good returns on its dividends of 2. 58 percent and an EPS of Rs. 30. 50. Even from the aspect of riskiness it is exposed to less than average risk.
But, since Indian Economy is transforming from an Agrarian Economy and the share of Agriculture in Indian GDP is reducing the future growth prospects for this business may get restricted due to this fact. Infosys Technologies: [pic] Performance in FY07 Infosys Technologies doesn’t have debt in its capital, which implies it is completely owned by its shareholders which imply that less is divided amongst each shareholder with a dividend yield of only 0. 57 percent. But, since the company has very strong fundamentals it can be invested into for the stable part of the portfolio as these blue chip companies have a very less chances of a major fall in earnings or share prices.
Northgate Technologies Ltd. : [pic] Performance in FY07 Northgate Technologies has the highest ICR of 135. 13 as it does not have any debt in its capital which inturn has an impact on the yield to its ordinary shareholders which is visible by the yield earned by its dividends which is 0. 92 percent. Currently trading at a PE of 28. 57x it can be considered for investment due to the strong growth potential in the innovative technologies being introduced by the company. As it is still in the phase of growth it can be considered to be an avenue for investment that is exposed to moderate levels of risk and return. New Delhi Television Ltd. : [pic] Performance in FY07
NDTV seems to be an overpriced security trading at PE of 86. 43x which is the highest but it is a company with very high risk levels at ICR of -0. 57 percent and a ROCE of -3. 17 percent. But its current and quick ratios are at appropriate levels. It is yielding a low returns on its dividends of 0. 25 percent and that on its earnings of 1. 29 percent which is the lowest in the group. But it can be considered for investment only on the grounds of growth prospects in this industry, so that adequate diversification can be accomplished to take advantage of growing per capita incomes in the country. Gujarat Mineral Development Corporation Limited: [pic]
Performance in FY07 GMDC has the highest dividend payout ratio of 55. 53 percent and is therefore yielding a return on its dividends of 10. 52 percent with a ROCE of 11. 01 percent. From the aspect of riskiness it is considered to be having more than average risk since it has a low quick ratio implying that its current assets are more in the form of inventories also it has a high concentration of debt in its capital with an ICR of 2. 65 percent. Jain Irrigation Systems Ltd. : [pic] Performance in FY07 This company belongs to the miscellaneous sector having a DPR of 13. 23 percent with an earnings yield of 8. 87 percent currently trading at 27. 1 x seems to be yielding good returns considering from the aspect of riskiness it has a high concentration of debt than equity in its capital allocation with an interest coverage ratio of 2. 53 percent it seems to be yielding high returns exposing the portfolio to high risk. Shiv-Vani Oil & Gas Exploration Services Ltd. : [pic] Performance in FY07 This company has the policy of not giving out any dividends to its shareholders rather reinvesting it into the business. This company can be considered to be exposed to less than average risk levels because of Current, Quick and ICR with the only concern being the high concentration of debt in its capital which is 2. 4 unit of debt for every one unit of equity. From the aspect of returns it is yielding higher than average returns currently trading at a PE of 37. 91x, it can be considered as a safe investment. Bombay Dyeing & Mfg. Co. Ltd. : [pic] Performance in FY07 This company has the highest concentration of debt in its capital i. e. 3,21 units of debt for every one unit of equity which is the reason behind a low ICR, Quick and current ratio. But, it seems to be an overpriced share with currently trading at PE of 58. 16. It can be considered for investment on the grounds of backing it has from the Wadia group of companies. Divi’S Laboratories Ltd. : [pic] Performance in FY07
This company does not have the policy to give out dividends rather they believe in yielding capital appreciation for its shareholders. It can be considered as a safe investment with all the risk ratios at appropriate levels, it is also yielding good returns to its shareholders with an EPS of Rs. 148. 50 and yield on earnings at 6. 53 percent level. Lupin Ltd. : [pic] Performance in FY07 Lupin seems to be an underpriced share with a PE of 16. 12 and its dividends yielding a return of 1. 65 percent and a ROCE of 21. 93 percent and dividends of Rs. 10 per share. Considering from the aspect of riskiness all the ratios are at appropriate levels, it can be concluded to be a low risk and average returns yielding company Bharati Shipyard Ltd. : [pic] Performance in FY07
Bharati ship yard is yielding less return on dividends paid by of 0. 86 percent, with an EPS of Rs. 32. 51 and all the risk ratios at appropriate levels. Bharati Shipyard can be regarded as an underpriced security especially with the growth propects in the shipping industry especially due to increasing foreign trade in the country. J S W Steel Ltd. : [pic] Performance in FY07 JSW steel is yielding much more than average returns on its dividends of 2. 53 percent with an EPS of Rs. 85. 44. Keeping in view the risk ratios it can be considered as a high risk company but with yielding high returns. Therefore, it can be concluded an underpriced security trading s PE of 5. 7x with the amount of returns its yielding even though it is exposing the portfolio to higher risk. Jindal Saw Ltd. : [pic] Performance in FY07 With the growth prospects in steel sector this security seems to be underpriced as currently is being traded at a PE 9. 26x and earnings yielding returns of 18. 87 percent. Even from the aspect of riskiness it is considered to be average risk as all the ratios are at appropriate levels except Quick ratio which implies that current assets are more in the form of inventories which cannot be liquidated in an unforeseen circumstance. Jindal Steel & Power Ltd. : [pic] Performance in FY07 JSPL is the company yielding the highest EPS of Rs. 228. 0 and the highest dividend per share of Rs. 18. From the aspect of riskiness it is considered to be a highly risky investment from the aspect of current and quick ratio but the interest cost can be easily covered by the company’s financials. Amtek Auto Ltd: [pic] Performance in FY07 This company if considered from the aspect of riskiness it carries less than average risk with quick ratio of nine and current ratio of 12. 18 but the returns is yielded is less than its counterparts in the same domain which is the major reason this company is not considered to be a viable option for investment. Motherson Sumi Systems Ltd. : [pic] Performance in FY07
The company has performed pretty well in FY07 especially with the budget completely in the favor of this sector it has been well positioned to leverage the benefits of the same by yielding a return on total capital invested equal to 27. 82 per cent and EPS of Rs. 4. 86 yielding returns on dividend of 2. 09 per cent. From the aspect of riskiness this company is considered to fall in the bracket of low risk due to a high interest coverage ratio. It can be considered risky only due to a low Quick ratio due to a large amount of current assets in form of inventories. Escorts Limited: [pic] Performance in FY07 The company has yielded good returns on its earnings as high as 30. 6 per cent being the third highest in the group of selected companies but it is exposed to very high levels of risk with a low on current, quick and interest coverage ratio and also the company is not paying any dividends to its shareholders it is not yielding adequate returns. Maruti Suzuki Limited: [pic] Performance in FY07 The company has performed very well in the last FY yielding EPS of Rs. 54. 50 and ROCE of 34. 4 per cent. Considering from the risk aspects the company has very less amount of debt i. e. 0. 11 units of debt for every one unit of equity, thereby it has a very high interest coverage ratio of 59. 39 per cent and current and quick ratios are also at appropriate levels.
Therefore, in the domain of Automobiles Amtek Auto is not considered to be a feasible for investment due to its inability to venture on the opportunities that have come its way as the other three companies have appropriately ventured upon. Conclusion This chapter has analyzed each of these companies making use of risk and return ratios in order to categorize these companies on the basis of parameters like high risk, low risk, high return and low returns so as to determine which of these companies can be considered as a part of a portfolio and how to invest adequately into these companies so that the joint motive of capital safety as well as capital appreciation can be realized. Chapter Four: | |Optimal Portfolio Construction & Correlation Analysis | |(This chapter aims at designing an optimal portfolio using the Modern Portfolio Theory so as to | |determine the allocations assigned to each of these securities so that the investible surplus can| |be adequately invested to achieve a well diversified portfolio. ) | Optimal Portfolio: The following table shows the optimal portfolio constructed making use of the adjusted share price data of last three years i. e. March 2005-2008. The following are the allocations corresponding to each share from the investible surplus to yield good returns. Table 4. 1: Lists the percentage allocation to each of these securities in the optimum portfolio. [pic] From the above portfolio it is observed that Bharti Airtel of telecommunications sector having a PE of 44. 5x and yielding a return on capital employed equal to 46. 1 per cent is absorbing the highest proportion of the investible surplus. But, if considered from the aspect of riskiness it is considered to be moderately risky investment with a low current ratio of 0. 35 units and very low quick ratio of 0. 14. The next highest investment is in HDFC Bank from the banking domain having a PE of 28. 58x and return on capital employed at 47. 57 per cent of the total invested capital is also a risky investment because of high debt- equity ratio at 0. 95 units and interest coverage ratio of 1. 51, since the company is possessing a very high leverage it is in a position to yield good returns for its equity shareholders.
Next on the portfolio is Reliance communications from the telecommunications domain which is company trading at 66. 93x which is the highest in this sector the major reason being the strong backing that it possess from the Reliance Group of Companies. Further, the portfolio has been diversified to maintain adequate levels of riskiness along with providing adequate returns. Keeping in view to allocate the surplus in such a manner that adequate diversification can be undertaken across sectors rather than concentrating into a few sectors thereby reducing the amount of volatility that the portfolio is exposed to and reducing the impact on consistent returns. Two securities Adani Enterprises from trading sector which was attracting 2. 3 per cent investment in the portfolio of reliance growth and Amtek Auto Ltd from the automobiles domain has been excluded from the Optimal Portfolio as it was yielding returns less than cut off point determined in the model. Observed Portfolio: Table 4. 2: Lists the percentage allocation to each of these securities in the portfolio of Reliance Growth mutual fund as on 31st March 2008. [pic] DEGREE OF CORRELATION The degree of Spearman’s rank correlation between the observed portfolio of Reliance Growth and Optimal Portfolio is very less of . 0939 which shows that the theoretical views are not being followed in the operation of these mutual funds rather they are investing on the basis of some unknown factors or intuition of the Fund Manager. The returns from the portfolio calculated on the basis of average returns over the considered period are 47. 3 percent per year which is lower than returns yielded by the allocations to these securities in the observed portfolio of Reliance growth which is yielding returns equal to 52. 35 percent per year considering the average returns over the period considered. Conclusion: Thereby, it can be concluded that the optimal portfolio is considering the risk-return parameters while deciding the allocations to the various securities but it is designed keeping in view moderate riskiness thereby it is yielding lesser returns than the Reliance growth which is considered to be an aggressive fund but a consistent performer in the mutual fund arena, but in the optimal portfolio the risk levels are maintained appropriately across allocation to various securities.
As if an individual invests in securities he may not have the mindset to expose its money to such high risk levels, he may rather settle at lower returns keeping in view the capital safety criterions. | | |Chapter Five: | |Conclusion | |(This chapter aims at summarizing and concluding the study. ) | CONCLUSION The study concludes that there is a very low degree of correlation of . 939 between portfolio of Reliance growth mutual fund and that of the optimal portfolio constructed in this study. The expected returns are calculated for the optimal portfolio which yields 47. 83 percent per year which is slightly lower than returns yielded by the observed portfolio of Reliance growth i. e. 52. 35 percent per year calculated on the basis of average monthly returns over the period March 2005 to March 2008. This difference can be attributed to the fact that Optimal Portfolio’s risk exposure is 0. 63 percent as compared to Reliance growth of 6. 98 percent. This is due to the fact that the optimum allocation is such that it is exposed to lowest possible risk and is yeilding highest possible returns provided the level of risk.
Similarly their may be other possible allocations but it will either expose the portfolio to a higher level of risk thus yeilding higher returns or a lower level of risk and lower returns. Therefore, it can be concluded that the Optimal Portfolio is the best possible allocation on the efficient frontier, other allocations are possible but with all possessing different combinations of risk and returns. Sectoral Allocations of the Portfolio’s: Figure 5. 1: Portrays the allocation in the Observed Portfolio and Optimum Portfolio to various sectors. [pic] Optimum portfolio is well diversified in terms of sectoral allocation with a little biased towards the telecommunications sector absorbing 15. percent which is considered to be bullish due to the communication vertical and with majority of the Indian telecom service providers as they are offering new breed of services such as mobile TV, broadband and IPTV. Followed by banking sector having a share of 12. 3 percent as after the farm loan waiver and forex derivative losses in the Union Budget 2008 has caused huge price and valuation distortions in banking stocks making them prospective investments for long term. Both Pharma and Diverfied sectors have equal allocation of 7. 8 percent. Various other sectors are absorbing between 5 percent to nil of the overall allocation which makes it less volatile due to allocation of twenty five different sectors.
Observed portfolio has the highest sectoral allocation towards diversified of 9. 3 percent with a which is considered to be a viable option since operations of these companies are not concentrated in one product thereby even if a particular product is losing in the market other products can save the bottom line of the company. Followed by Steel sector having a share of 7. 2 percent since the growth prospects in this sector over a long term period. Miscellaneous, Pharma Construction and steel & power sre absorbing approximately equal shares of 6. 8 percent therefore a source of high concentration in sectors where high pricing presures exist from the government which in the future may eat up the companies bottom lines.
Various other sectors are absorbing between 5 percent to nil of the overall allocation. The study finds that though the observed portfolio (of Reliance growth) is yielding higher returns at the same time it is exposed to higher risk since its highly concentrated in a few sectors allocation meager allocations to other sectors. On the other hand, optimal portfolio is not concentrating in a few sectors rather allocating less to medium allocations to other sectors. Therefore it is found out to be the best possible allocation on the Efficient frontier. REFERENCES: Books: • William F. Sharpe, Gordo J. Alexander and Jeffery V. Bailey (Sixth Edition), “Investments”- Chapter 6-7. • Edwin J. Elton and Martin J. Gruber, Fifth Edition. “Modern Portfolio Theory and Investment Analysis” – Chapter 7-9. • By Donald E. Fischer and Ronaki J. Jordan(1995). “Security Analysis and Portfolio Management” Chapter 9-12. Journal Articles: • Edwin J. Elton , Martin J. Gruber and T. Clifton Green(2004), “The Impact of Mutual Fund Family Membership on Investor Risk” URL-http://pages. stern. nyu. edu/~mgruber/working%20papers/mutual%20fund%20family%20membership. pdf • Gregory Curtis (2002) “Modern portfolio theory and Quantum mechanics” URL-http://www. greycourt. com/whitepapers/WhitePaper020-MPT. pdf • Debashish Dutt (2006), “Constructing an optimal portfolio using Sharpe’s single index model”, URL: http://www. myicwai. com/knowledgebank/fm09. df • Lingjie ma and Larry pohlman (2005), “Return Forecasts and Optimal Portfolio Construction: a Quantile Regression Approach” Url- http://www. fma. org/Chicago/Papers/equityQR2. pdf Published Government Reports: • Government Of India(2008), Economic Survey of India 2008, Ministry of Finance, New Delhi Articles from Websites: • Business Line “Oracle bullish on telecom vertical” Dated 15th December 2006. URL http://www. thehindubusinessline. com/2006/12/16/stories/2006121603130400. htm • CNBC TV-18, “Bullish on public sector banking space: Sundaram BNP” Dated 17th April 2008 URL-http://www. moneycontrol. com/mccode/news/article/news_article. php? utono=334629 • TRAI (2008) “The Indian Telecom services Performance Indicator Report for the Quarter ending March
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