FIN 340 Final Project

Brandon Dill

Client Analysis

My first new client, Ezra, is a young investor with an existing portfolio and a recent

windfall of $60,000. This windfall came at a very advantageous time for Ezra, as he has

relatively expensive near-term plans with his significant other. He can use a portion of the

$60,000 to pay for an engagement ring and his wedding, and he won’t have to withdraw from his

savings or investment account. After paying for his engagement and wedding, Ezra should have

around $40,000 remaining to invest. Since Ezra has a comfortable amount in savings and already

contributes a portion of his salary to a 401k plan through his work, he can use this new capital to

diversify his portfolio. Ezra understands the fact that he could potentially lose money in an

aggressive investment strategy, but he is willing to take risks since he has a comfortable income,

established savings, and time to recover if he experiences a significant loss. After considering

Ezra’s situation and some of the comments regarding the future of his portfolio, Ezra’s return

objectives align with an aggressive growth strategy. Ezra realizes that with his income level and

newly acquired capital, he can afford to take short-term risks to potentially stimulate his

portfolio. Even if Ezra were to lose the entire $40,000, he would be adding to his investment

portfolio, he would still be in the same situation he was before. However, if he accepts short term

risks and manages to double or triple that investment, he would be setting himself up with a

stronger capital base to manage long-term. A short-term success with his newfound capital could

lead Ezra to having the ability to retire sooner and more comfortably. Since Ezra is only in his

mid-20s, he doesn’t have to concern himself too much with the liquidity of his assets. While he

may prefer to trade some stock selections in the short-term, it is likely that he would parlay any
gains from shares sold into another position. Most of his portfolio would be focused on long-

term positions since Ezra is many years away from being able to retire.

Ezra’s Growth Investment Statement

 Contribute 5% of income to Savings

 Contribute 10% of income to company’s 401k plan

 Contribute 5% of income to a Roth IRA account

 Use $10,000 of windfall capital in high-risk stocks focused on short-term gain

 Allocate $15,000 of windfall capital to aggressive Mutual Funds and ETFs

 Allocate remaining $15,000 to blue chip long-term investment stocks

 Contribute a further 3% of income to subsequent investments in Mutual Funds/ETFs,

new short-term stock positions, and buying more shares of blue-chip stocks

My other new clients are a couple with four kids who are nearing retirement age and have an

established and strong existing portfolio. While Jacob and Rachel are approaching retirement, they

realize the demands of sending four kids to college will likely mean that they will need to continue

working for over a decade. The couple earns a high level of income, so they know they will have

to remain moderately aggressive with their investments so they can continue their lifestyle in

retirement. Jacob and Rachel do live below their means, so they don’t plan to live extravagantly

in retirement either. Jacob and Rachel were firm in their desire to avoid a large loss as they don’t

have time to recover from such a loss. From what the couple has told me about their portfolio

goals, it seems they desire to maintain consistent and predictable returns. Jacob and Rachel have

expressed interest in investing in bonds, but also plan to draw from their investment portfolio in
retirement, so some of their capital needs to remain in accounts with high liquidity. The couple

does not seem to have much risk of an emergency situation since they have had long-term well-

paying jobs with presumably solid healthcare plans. Due to this, Jacob and Rachel don’t have to

worry much about keeping a large amount in savings, and it would be preferable to keep their

portfolio insulated from inflation.

Jacob and Rachel Investment Statement

 Maintain 10% of portfolio in high yield savings account

 Invest 20% of portfolio in high yield bonds

 Invest 20% of portfolio U.S. Treasury Securities, Money Market accounts, bank CDs

 Invest 30% in blue chip stocks and high dividend paying stocks

 Allocate 10% of portfolio to aggressive Mutual Funds and ETFs

 Maximize investment in Roth IRA account

 Invest 15% of income into company investment plan

 Invest 10% of portfolio into 529 College Savings Plan

Stock Analysis

After researching the list of securities, bonds, and ETFs from the provided list, the five

that I decided to conduct valuations on were Coca-Cola (KO), Baxter International (BAX),

Netflix (NFLX), Akamai Technologies (AKAM), and SPDR S&P 500 ETF Trust (SPY). Based

on the valuation models used for each stock, their current market prices, and their historical

performance, the expected rate of return was calculated for each.

 I applied the P/E ratio valuation model for the KO stock (see pg.10 for calculation). The

P/E ratio for Coca-Cola based on the trailing twelve months reported earnings per share was,

49.44. The P/E ratio valuation method was used for this stock, because it is a model that can

easily compare its viability against other companies in the industry, such as Nestle and PepsiCo.

The P/E ratio for KO is significantly higher than the industry average of 22.6 (snhu.edu, 2019)

which indicates that Coca-Cola may be overvalued at this time. Given that Coca-Cola has

achieved a 14.17% YTD return, an investor may expect that the market price could soon face a

short-term decline. However, KO represents a safe investment that an investor could reasonably

expect a moderate return given its 5-year annual growth rate of 5.59%. After weighing Coca-

Cola’s historical performance with its recent growth, while considering that the market price

could drop due to an inflated P/E ratio, the expected 1 year rate of return for KO was estimated

to be an 8.8% return.

The P/E ratio valuation model was also used for Baxter Technologies (BAX) (see pg.10

for calculation). The P/E ratio for BAX based on the trailing twelve months of reported earnings

per share was, 27.58. The P/E valuation method was used to compare BAX with some of its

industry competitors, such as 3M and Stryker. Based on the industry average of 36.09 (snhu.edu,

2019), Baxter Technologies could be an undervalued stock at this time. BAX has performed very

well YTD of 32.33%, which has followed the exceptional annual growth rate of 16.42%. The

favorable P/E ratio and historical performance indicates that the market price of BAX should

continue to increase at a high rate. The expected one year return based on the historical research

and valuation was estimated to be 21.9%.

For SPDR S&P 500 ETF Trust (SPY), the dividend valuation model was used. The fair

value score for SPY was calculated to be 63.67 based on the expected dividends for next year,
which were divided by the cost of equity with the expected growth rate subtracted from cost of

equity (see pg.10 for calculation). The dividend valuation method was used because investors

receive an annualized dividend payout of $5.73 per share (dividend.com, 2019). Also, since SPY

is a selection of stocks that tracks the S&P 500 and not an individual company, a P/E score

cannot be calculated. The downside of SPY’s dividend payout is that without a payout increase

from this year to last year, it is difficult to determine what the growth rate of the payout will be

in the future. The fair value score for SPY would be higher if the growth rate were used in the

calculation. However, an investor can still expect an immediate return, as well as a long-term

return from SPY. The expected one year return based on historical research and current

valuation, is estimated to be 11.4%.

The FCFE valuation model was applied for Netflix (NFLX). This model was used

because Netflix is a company that is constantly acquiring new licenses to content. The free cash

flow to equity model is an efficient method to analyze how the company operates, and how their

capital expenditures and debt effect the market price of the stock. With an FCFE of 1.03 billion

(see pg.10 for calculation) and a historical trend of positive FCFE, Netflix seems positioned to

continue to climb at a steady rate in the stock market. The market price of NFLX has achieved

growth of 15.42% YTD, and a five year annual growth rate of 36.34%. There are some concerns

that the market price could fall due to increasing competition and Netflix losing the rights to a

portion of their content. However, Netflix has continually increased the amount of original

content that they offer, which has thus far separated the platform from others like it. Based on the

valuation model and the historical performance of NFLX, an investor could expect a one year

return of 14.5%.
 The P/E valuation model was used to estimate the value of Akamai Technologies

(AKAM). The P/E ratio for AKAM based on the trailing twelve months earnings per share, was

43.09 (see pg.10 for calculation) which is nearly on par with the industry average P/E ratio of

41.8 (snhu.edu, 2019). The P/E valuation model was used for Akamai Technologies to compare

it to the value of industry competitors. Akamai has achieved a steady 5 year annual growth rate

of 8.55%, but investors should be encouraged by AKAM’s YTD performance with a 52.36%

return. Akamai’s YTD return is actually higher than its 5 year return, which makes the 8.55%

five year growth rate a misleading statistic. Investors should still keep their eye on Akamai for an

opportunity to potentially achieve high returns. Based on the P/E valuation and historical trends

of AKAM, an investor could expect a one year return of 21%.

Portfolio Development

For my client Ezra, I would recommend the stocks discussed (KO, BAX, SPY, NFLX,

AKAM) to add to his portfolio. Ezra is an investor that can afford the potential of negative

returns in the short term, so he can take on a riskier selection of stocks for his portfolio. To

mitigate some of Ezra’s risks, safer selections like KO and SPY, could hedge against potential

losses. NFLX market price has skyrocketed over the last two years, and projects to continue to

rise, but uncertainty in the industry and talks of raising prices could lead to Netflix losing

customers. Akamai is the other selection that raises questions of uncertainty, since its

performance is based almost solely on the most recent year’s returns. Ezra should expect Baxter

international to be his highest performing stock, given its recent and historical performance along

with its P/E valuation significantly below its competitors. As determined previously, after paying

for his wedding expenses, Ezra will have $40,000 to invest. Based on Ezra’s preferences for risk,
I would advise him to allocate his funds to the five selections as follows: (35% BAX, 30%

AKAM, 15% NFLX, 10% SPY, 10% KO). Using CAPM (Beta) calculations, the expected return

for Ezra’s portfolio would be 10.34% (see pg.11 for calculation). For my clients Jacob and

Rachel, who are reaching retirement age and are more concerned with capital preservation, I

would have recommended a safer selection that would’ve included Treasury Bonds and lower

expected rate of return with a lower risk to the clients. Ezra’s portfolio’s expected standard

deviation was calculated to be 21.26% (see attached Excel spreadsheet). For Jacob and Rachel’s

portfolio, I would have structured a selection that was more predictable and less risky, with a

smaller expected standard deviation.

Portfolio Performances

The stocks that were selected for Ezra’s portfolio were considered with his return

objectives and risk tolerance in mind. Since Ezra is still young and just beginning his portfolio,

he is willing to accept a high amount of risk and understands that short-term losses are possible

and also acceptable. The portfolio aligns with his risk tolerance, because BAX, AKAM, and

NFLX are all companies with potential to perform well beyond their current market value.

However, these stocks all have relatively high P/E ratios, with the risk of declining 30%-40%,

which is a risk that Ezra has stated that he is willing to take. While Ezra is comfortable with

losing that amount, as his adviser, it would be in my best interest to protect Ezra from losses and

maintain his trust. Therefore, the investments in SPY and KO were selected to hedge against

losses. These selections are more predictable, as SPY tracks the S&P 500, and KO is a blue-chip

stock that is likely to achieve moderate and steady value over time. As referred to above, Ezra

can expect a one year return of approximately 10% for this selection of stocks. If Ezra’s portfolio
consistently performs at this rate, he would double his initial investment every seven years. Since

Ezra could realistically work for 5 seven year periods until retirement, so his investment would

double five times.

Ex-Post Portfolio Return

Holding Period Return

KO: $4,000 (1.06) = $4240

BAX: $14,000 (-1.06) = $13,160
AKAM: $12,000 (1.21) = $14,520
SPY: $4,000 (1.09) = $4,360
NFLX: $6,000 (1.18) = $7,080
Total Portfolio Value: $43,360
Holding Period Return: 8.4%

Sharpe Ratio

Portfolio Ratio: Expected Portfolio Return (8.4%) Risk Free Rate (.75%) Portfolio Standard
Deviation (13.9%). Sharpe Ratio: .55
Growth Benchmark Ratio: Expected Portfolio Return (9.6%) Risk Free Rate (.75%) Portfolio
Standard Deviation (13.9%). Sharpe Ratio: .64

Treynor’s Measure

Portfolio Measure: Projected Portfolio Return (8.4%) Risk Free Rate (.75%)
Beta of Portfolio (1.066). Treynor’s Measure: 7.18

Jensen’s Measure

Portfolio Measure: Expected Return- .75 + 1.066 (9.6-.75) = 10.13 -- Jensen’s Measure = -1.73
 References

Dybek, M. (2019, January 30). Netflix Inc. (NFLX): P/FCFE. Retrieved from https://www.stock-

analysis-on.net/NASDAQ/Company/Netflix-Inc/Valuation/Price-to-FCFE#FCFE

SPY: Dividend Date & History for SPDR S&P 500. (n.d.). Retrieved from

https://www.dividend.com/dividend-stocks/uncategorized/other/spy-spdr-sandp-500/

The Long Term Perspective on Markets. (n.d.). Retrieved from https://www.macrotrends.net/

Yahoo Finance - Business Finance, Stock Market, Quotes, News. (n.d.). Retrieved from

https://finance.yahoo.com/
Valuation Calculations

KO: Market Price ($50.92) / TTM EPS ($1.03) = 49.44

BAX: Market Price ($81.90) / TTM EPS ($2.97) = 27.58

AKAM: Market Price ($80.14) / TTM EPS ($1.86) = 43.09

SPY: Expected Dividends Next Year ($5.73) / (cost of equity (.09) – expected growth

rate (.00) = 63.67

NFLX: (stock-analysis-on.net, 2019)

USD in Thousands

Net Income: $1,211,242

Net noncash charges: ($4,185,488)

Changes in operating assets and liabilities: $293,767

Net cash provided by (used in) operating activities: ($2,680, 479)

Purchases of property and equipment: ($173,946)

Acquisition of DVD content assets: ($38,586)

Proceeds from issuance of debt: ($3,961,852)

Issuance Costs: ($35,871)

Free Cash Flow to Equity: ($1,032,970)

CAPM (Beta) Calculations

BAX: (.75 x 9%) + .75% = 7.5%

AKAM: (1.34 x 9%) + .75% = 12.81%

NFLX: (1.57 x 9%) + .75% = 14.88%

KO: (.66 x 9%) + .75% = 6.69%

SPY: (1 x 9%) + .75% = 9.75%

CAPM Portfolio Return Calculations

$40,000 Invested

BAX (35%): $14,000 (1.075) = $15,050

AKAM (30%): $12,000 (1.1281) = $13,537.20

NFLX (15%): $6,000 (1.1488) = $6,892.80

KO (10%): $4,000 (1.0669) = $4,267.60

SPY (10%): $4,000 (1.0975) = $4,390

Total Return: $4,137.60

$4,137.60 / $40,000 = .1034 (10.34%)