Xavier Student Investment Fund
Creation of an Equity Fund
Proposal
Xavier Student Investment Fund Semiannual Meeting
December 6, 2007
XAVIER STUDENT INVESTMENT FUND
CREATION OF AN EQUITY FUND
PROPOSAL
XSIF Equity-Fund
Task Force
MBA Student Fund Managers
2007-2008 Student Fund Managers
 Mrinalini Ayachit
 David Dury
 David Beckett
 Andrew Lobas
 Scott Krajewski
 Michael Raidt
 Jonathan Pickard
 Nicholas Trivett
 Christopher Wimsatt
Board of Directors
Xavier Student Investment Fund
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J. Hunter Brown, Watson Wilkins & Brown, LLC
John E. Callahan, O’Connor & Company LLC
William Cousins, III, Cornerstone
William Effler, American Money Management
Brian Gilmartin, Trinity Asset Management
Coleman Goldsmith, Smith Barney
Richard Hirte, Vice President of Finance, Xavier University
R. Bryan Kroeger, US Bank
Lawrence Leser, E.W. Scripps
Ali Malekzadeh, Dean, William College of Business, Xavier University
Matthew McCormick, Bahl & Gaynor Investment Counsel
Joseph McManus, Morgan Stanley
James Pawlukiewicz, Department of Finance, Xavier University
Kim Renners, Ohio Casualty Group
J. Patrick Rogers, Gateway Investment Advisers, Inc
James Schade, Merrill Lynch
Shelly Webb, Chair, Department of Finance, Xavier University
1
CREATION OF AN EQUITY FUND
PROPOSAL
TABLE OF CONTENTS
1.
SUMMARY AND RECOMMENDATIONS
3
2.
FACTORS TO CONSIDER IN FORMING AN EQUITY FUND
6
3.
PROPOSED INDEX, STYLE, AND MANAGEMENT
9
4.
PORTFOLIO
17
5.
SIMULATED PORTFOLIO
18
6.
MANAGING THE EQUITY FUND WITH THE
FIXED-INCOME FUND
23
7.
FORMATION OF THE FUND
25
APPENDICES
APPENDIX A: FUNDAMENTAL ANALYSIS OF COACH USING
MULTIPLIER APPROACH
28
APPENDIX B: RISK-ATTRIBUTES MODEL
32
2
1. SUMMARY AND RECOMMENDATIONS
Background
On November 15th, 2004, the Xavier Student Investment Fund (XSIF) began managing
$1,000,000 of Xavier’s endowment as a fixed-income fund. Currently, the 2007-2008 XSIF
edition represents the sixth management team to assume the responsibility of the fixed-income
fund.
By most accounts, the XSIF fund experience has met the objectives that were proposed for the
fund when it was created:
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To provide students with hands-on experience in the establishment of investment
objectives and policies, identification of investment strategies for trading fixed-income
securities, and monitoring and reporting portfolio performance;
To enhance career opportunities for students and gain additional visibility for the Xavier
University finance program in the business community;
To extend and develop ties between Xavier University and the community of investment
professionals;
To attract high-quality students with an interest in business to Xavier;
To provide additional visibility for the Williams College of Business; and
To provide investment income to support the educational mission of Xavier University.
At the 2007 Xavier Student Investment Fund Annual Meeting, Father Graham raised the
question of whether the XSIF’s responsibility, as well as educational experience, should be
expanded to include the management of an equity fund. In a letter to Father Graham and the
Board of Trustees, the Xavier Student Government also expressed their interest and support for
the development of a student-managed equity fund. In response to this interest, the Xavier
Student Investment Fund Board of Directors recommended at their 2007 Annual Meeting that
the XSIF fund managers examine how a student-managed equity fund could be formed and
managed.
During the summer of 2007, the MBA XSIF Fund Managers formed a task force to examine the
construction and management of an equity fund. Led by Mrinalini Ayachit and David Beckett,
the Equity Fund Task Force examined:
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Different indices against which to manage the fund
Different investment styles and management approaches
Quantitative and qualitative models for evaluating sectors and companies
Data and informational sources for evaluating securities
Bloomberg data and analytical functions for evaluating indices, sectors, and companies
Bloomberg analytical functions for evaluating portfolios
Operational structures for managing the fund
In September, five fund managers of the new 2007 XSIF joined the task force. This group
worked with Mrinalini Ayachit and David Becket to:
3
 Complete the analysis
 Conduct mock exercises on selecting stocks
 Simulate an equity portfolio
The Task Force also held several meetings on the direction of the fund with Bill Effler,
Lawrence Leser, Matthew McCormick, Kim Renners, James Schade, Jamie Wilhelm, Tim
Kruse, and Shelly Webb.
Proposal
After completing its analysis on the construction and management of an equity fund, the Equity
Fund Task Force recommends that consideration be given to an equity index fund with the
following index, investment style, and strategic and management approaches:
 Index: S&P 500, with later consideration to changing the index to the S&P 900 or Russell
3000.
 Style: Combination of value and growth for S&P 500; later consideration to combinations of
value/large-cap, value/mid-cap, growth/large-cap, and growth/mid-cap.
 Strategy: Tactical strategy to determine the value and growth mix for the S&P 500; later a
tactical strategy to determine the allocation to value/large-cap, value/mid-cap, growth/largecap, and growth/mid-cap.
 Top-Down Approach: Use three-step approach: Macroeconomic, Industry, and Firm Analysis
To set up the equity fund, the Equity-Fund Task Force proposes that a student equity fund team
and an equity fund task force be formed:
 The Student Equity Fund Team would be responsible for setting up the initial fund based
on the index fund described in this report. They would also develop the operational
structure needed to manage the fund. The team would consist of several of the current XSIF
fund managers, two 2007 MBA fund managers, several finance majors (preferably juniors),
and several MBA students concentrating in Finance.
 The Equity Fund Task Force would be responsible for providing advice to the Student
Equity Fund Team and making recommendations on the fund’s overall structure, by-laws,
and management. This would include recommendations on whether the fund should be part
or separate from the fixed-income fund, the structure of the investment board, the MBA and
undergraduate arrangements for the management of the fund, and the trading and custodial
arrangements. The task force would also make recommendations to the Finance Department
concerning academic credits. The task force would consist of several members of the
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Finance Department, members of the XSIF Board, people nominated by the XSIF Board,
and a member of the Board of Trustees or a person or persons nominated by the Board.
To facilitate communications between the Equity-Fund Team, the Task Force, and the finance
department, the XSIF Equity Fund Task Force recommends that the XSIF Fund Advisor and
Professor serve on both the team and task Force.
Finally, the XSIF Fund Task Force recommends the following time table and tasks:
 March 1, 2008: The Equity Fund Team would be expected to complete its portfolio
construction. It would present a report to the Equity-Fund Task Force and the Department of
Finance.
 March 10, 2008: Equity-Fund Task Force would evaluate the portfolio and make its
recommendations. It would then submit a report to the XSIF Board.
 March 15, 2008: Special meeting of the XSIF Board to evaluate the recommendations of the
Equity Fund Task Force and Equity Fund Team. The XSIF Board would then make a
recommendation to the Department of Finance on the proposed equity fund.
 April 1, 2008: The Department of Finance would submit its recommendation to the Finance
Subcommittee of the Board of Trustees.
 April 15, 2008: If approved, the Department of Finance would begin selecting students to
manage the fund.
 June 15, 2008 or September 1 2008: XSIF Fund Managers would begin managing the fund.
The actual date would depend on the decision made on the type of MBA and undergraduate
management structure recommended for the fund.
In this report, a proposed XSIF Equity Fund is explained. The next section examines the issues
and factor involved in setting up an equity index fund. Section 3 delineates the features of the
proposed fund and explains how it could be managed. In Section 4, the portfolio is described and
in Section 5, the performance of a simulated portfolio is presented. Section 6 then discusses the
possible benefits of combining the management of the proposed equity fund with the current
fixed-income fund.
5
2. FACTORS TO CONSIDER IN FORMING AN EQUITY FUND
The development and management of an equity index fund requires determining the following:
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The index against which to manage the fund
The fund’s styles and sub-styles
The use of a passive or tactical management approach
The use of a top-down or a bottom up management approach
Index
The first step in constructing the fund is to select an appropriate index. Possible indices to
consider include:
 S&P 500: S&P 500 is a broad market portfolio. The index addresses the needs of investors
who want to allocate assets to a relatively large universe.
 S&P 900: S&P 900 is a broad market portfolio representing the large-cap and mid-cap of
the U.S. equity market. This combination addresses the needs of investors who want to
allocate assets to a broader large cap universe, beyond the S&P 500. S&P 500 makes up
approximately 92% of this index and the S&P Mid-Cap 400 makes up the remaining 8%.
 Russell 1000: The Russell 1000 Index offers investors access to the extensive large-cap
segment of the U.S. equity universe representing approximately 92% of the U.S. market.
The Russell 1000 includes the largest 1000 securities in the Russell 3000.
 Russell 3000: The Russell 3000 Index offers investors access to the broad U.S. equity
universe representing approximately 98% of the U.S. market: large-cap, mid-cap, and smallcap stocks.
The broader indices would give the fund an exposure to a larger number of companies and the
ability to classify the fund into more equity styles (e.g., large, mid cap, and small cap).
Style and Sub-Styles
The second step in forming the index fund is to identify the specific style of management. Equity
management styles are typically broken into two major categories: value stocks and growth stocks.
Sub-categories are often formed within these two groups: small cap, large cap, low price-to-earnings
(P/e), high P/e, and the like. The most common way to classify value and growth stocks is to use a
stock’s relative price-to-book value ratio (P/B): growth stocks have relatively high P/B ratios; value
stocks have relatively low P/B ratios. One way to identify value and growth stocks is to rank the
6
stocks comprising a sample or an index by their P/B ratios.1 An alternative to the ranking method is
to use a mutiple-index measure that provides a score.2
Within a style, portfolio managers can create other groupings or sub-styles. Examples include:
1. Within a value or growth style, sub-styles based on size: small-size value, large-size value,
small-size growth, and large-size growth.
2. Within a value or growth style, sub-styles based on financial ratios.
3. Within a value or growth style, sub-styles based on financial ratios.
4. Within growth style, sub-styles based on high growth, low growth, above-average growth,
volatility, and the like.
5. Within a broad index, sub-styles based on size or ratios: S&P Mid Caps, S&P Small Caps,
or P/E growth (PEG) Portfolios.
It should be noted that the selection of a broader index would give the fund an exposure to a larger
number of companies and the ability to classify the fund into more sub-styles. For example, the
Russell 3000 consists of large-cap, mid-cap, and small-cap stocks, allowing value, growth or
value/growth blend styles to be combined with three sub-styles.
Investment Style Matrix
Value
Blend
Growth
Large Cap
Mid Cap
Small Cap
Passive or Active Management
The third step is to determine whether the management of the index fund is to be either passive or
tactical. The objective of a passive strategy is to replicate the specified index and style, while the
1
An example of a ranking approach would be to (1) Select a large sample of stocks (1,000) or
the stocks comprising a broad index; (2) determine the sample’s total market value; (3) compute
each stock’s P/B ratio; (4) rank stocks from low to high by P/B; (5) define value stocks as all
those stocks that encompass the first half of the market value (or some defined percentage); (6)
define growth stocks as all those stocks that encompass the second half of the market value (or
some percentage).
2
D
For Example: Score i  w 1    w 2 ROE i  w 3 Variation in Earnings
 P i
7
i
aim of a tactical strategy is to enhance returns by changing the asset mix in response to changing
market conditions or return patterns. For example, a ‘Value/Growth Stock Changing Strategy’
would involve changing or tilting a portfolio from value to growth or growth to value when
conditions dictate. Another tactical approach is to use a factor model to change a portfolio based on
the stock’s sensitivity to certain factors: inflation, interest rates, and aggregate output.3
A study of the monthly returns earned from value and growth style investments by Leinweber,
Arnolt, and Luck found that $1 invested in 1975 in a value-grouped portfolio would have grown to
$23 by 1995, while $1 invested in a growth-grouped portfolio would have grown to only $14.
However, the study also found that in 45% of the months in the sample, growth stocks
outperformed value. This suggests that with perfect foresight, an investor switching from growth to
value would have realized $45.
More recent findings from the Russell U.S. Index fact sheet show that over longer time periods
of 5 years and 10 years, value stocks have generally outperformed growth. However, the study
also found that there were multi-year periods when the growth stocks did better than value ones.
For example, during the technology bubble period, as well as this past year, growth stocks
outperformed value stocks. These findings indicate advantages to a tactical strategy if an
effective ‘style-switching discipline’ can be developed.
Top-Down or Bottom-Up
The final step is to determine whether to use a top-down or bottom up approach. Fundamental stock
analysis that employs a top-down method typically uses a three-step approach in which
economic and industry analyses are used as inputs in selecting a stock. This approach starts with
an analysis of the aggregate economy and an identification of macroeconomic trends. The
macroeconomic analysis is, in turn, followed by an industry assessment to determine which
sectors will do well given the overall economic outlook. Finally, there is assessment of
companies within industries to try to determine which stocks investors should buy. In contrast, a
bottom-up approach involves studying companies and selecting stocks independent of economic
and industry factors. Many security analysts and academics advocate the top-down approach to
stock selection as preferable based, in part, on evidence that shows that general economic
conditions tend to affect all companies. A recession, for example, not only adversely affects the
earnings of bad companies, but good companies as well. The top-down approach is also
empirically supported; studies have shown that there is a significantly high percentage of both
company and industry earnings that can attributed to aggregate economic activity.
3
Portfolios constructed from multifactor/arbitrage pricing theory analysis are called factor
models. These include statistical and macro fundamental models. Statistical factor models are
based on explaining security and portfolio returns based on artificial factors created from factor
analysis. Many of the macro fundamental models are rooted in the works of Chen, Roll, and
Ross and Burnmeister and McElroy. Most of these are proprietary models. However, one
published model of note is the Risk Attributes Model – RAM (see Appendix B).
8
3. PROPOSED INDEX, STYLE, AND MANAGEMENT
Given the different indices, styles, sub-styles, and management approaches, the XSIF Equity
Fund Task Force recommends the construction and management of an equity-style index fund
with the following properties:
 Index: S&P 500, with later consideration to changing the index to the S&P 900 or Russell
3000.
 Style: Combination of value and growth for S&P 500; later consideration to combinations of
value/large-cap, value/mid-cap, growth/large-cap, and growth/mid-cap.
 Strategy: Tactical strategy to determine the value and growth mix for the S&P 500; later a
tactical strategy to determine the allocation to value/large-cap, value/mid-cap, growth/largecap, and growth/mid-cap.
 Top-Down Approach: Use three-step approach: macroeconomic, industry, and firm analysis
Index
The S&P 500 is a relatively broad index that can be divided into value and growth stocks. The
plan to later move the index to the S&P 900 is based on increasing the number of mid-cap stocks
for consideration. Moreover, once the fund managers develop an expertise in fundamental stock
analysis, consideration could then be given to changing the index to either the Russell 3000 or to
forming a customized index (e.g., 85% in S&P 900 stocks and 15% in small-cap stocks).
Style: Value and Growth Using Tactical Allocation
Value stocks generally experience less volatility than growth stocks and potentially offer
stronger performances during slower-growth environments. By contrast, growth stocks are more
volatile and typically are associated with higher levels of risk, but higher expected returns. They
tend to outperform value stocks during stronger growth periods. By combining both growth- and
value-oriented stocks, the fund realizes better diversification benefits.
The fund managers would be responsible for making the tactical decision on the value/growth
mix. This would require developing an expertise in estimating the sensitivities of growth- and
value-oriented stocks to general economic and market conditions and in forecasting changes in
those conditions. Operationally, the fund managers’ decision would be either to keep the valuegrowth mix similar to the index or to tilt the fund more towards one style. Similar decisions
would be made if the fund were broken into sub-styles. For example, in determining the
allocation to value/large-cap, value/mid-cap, growth/large-cap, and growth/mid-cap, managers
would again have to develop an expertise in estimating the sensitivity of different style-orientated
stocks to general economic and market conditions and in forecasting changes in those conditions.
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S&P 500 Pure Style Indices
In initially forming the portfolio, one approach is to use the S&P 500 pure styles indices to
define and identify value and growth stocks. The S&P Style Series puts every constituent of the
parent index into a style basket. The style series only includes those constituents of the parent
index that exhibit very deep growth or value characteristics. The Pure Style indices present
investors with a concentrated set of growth and value stocks that exhibit strong style
characteristics. The style indices measure growth and value across separate dimensions using the
following seven factors – three to measure growth and four to measure value:
Growth Factors
1. 5-Year Earnings-per-Share Growth Rate
2. 5-Year Sales-per-Share Growth Rate
3. 5-Year Internal Growth Rate
 Internal Growth Rate = (ROE)(Retention Rate)
1.
2.
3.
4.
Value Factors
Price-to-Book Value Ratio
Price-to-Cash Flow Ratio
Price-to-Sales Ratio
Dividend Yield
These factors are then standardized and used to compute a growth score and a value score for
each company. The growth score is calculated as the average of the three growth factors and the
value score as the average of the four value factors. The scores are then used to determine each
company’s style attractiveness.
Currently, the S&P Pure Growth Style Index contains 151 stocks and the Pure Value Style Index
contains 141 stocks. If this approach were used to define value and growth styles, then from this
investment universe, fund managers would have 292 stocks from which to select. Excluded from
the list would be 208 of the S& P 500 stocks that would be considered a mix between pure value
and pure growth.
Sectorwise Allocation
An index can be broken down into sector allocations. In managing the portfolio, fund managers
can determine the allocation to each sector relative to the index using sector and industry
analysis. They can also evaluate the overall fund relative to the index by knowing its sector
breakdown. Bloomberg (using the BICS method) initially breaks down an index into the
following 10 sectors:
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1. Basic Materials
6. Energy
2. Communications
7. Industrial
3. Consumer Cyclical
8. Technology
4. Consumer Non Cyclical
9. Healthcare
5. Financial
10. Utilities
Each Sector can be further classified into various industries and sub-industries.
If the fund were managed in terms of S&P 500 pure growth and value style indices, the 151 pure
growth stocks and 141 pure value stocks could be broken into the 10 sectors, with the stocks in
each sector being further classified as growth or value. Exhibit 1 shows a sector breakdown of
the 292 stocks by growth and value.
Exhibit 1: Value and Growth Stocks by Sector
Sectors
Energy
Materials
Industrials
Consumer discretionary
Consumer Staples
Healthcare
Financials
Information Technology
Communiations
Utilities
Growth Value Total
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6
14
25
47
0
10
24
10
1
3
14
14
17
17
0
33
4
14
25
17
20
28
42
64
0
43
28
24
26
Total
%
5.82%
6.85%
9.59%
14.38%
21.92%
0.00%
14.73%
9.59%
8.22%
8.90%
Growth
%
9%
4%
9%
17%
31%
0%
7%
16%
7%
1%
Value
%
2%
10%
10%
12%
12%
0%
23%
3%
10%
18%
S&P500
%
10.79%
3.12%
11.43%
10.20%
9.29%
11.67%
20.77%
15.45%
3.75%
3.51%
151
141
292
Note: The zero allocation to healthcare is a result of this sector not being either pure growth or value.
Given a listing of possible value stocks and growth stocks by each sector, fund managers would
be able to conduct sector analysis to determine which sectors to overweight and which to
underweight relative to the index. Moreover, when managers combine sector analysis with the
tactical strategy they want to implement, they will be able to determine how the growth and
value allocations in each sector should be tilted.
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Top-Down, Three-Step Approach
A top-down, three-step approach uses macroeconomic, industry, and firm analysis to evaluate and
manage the overall portfolio, sectors, and stocks. For this portfolio, fund managers would:
 Use macroeconomic and market analysis combined later with factor analysis to determine
changes in the allocation to the value and growth styles relative to the S&P 500 index (and
later to determine changes in the allocation to value/large-cap, value/mid-cap, growth/largecap, and growth/mid-cap).
 Use macroeconomic and market analysis as information for industry and sector analysis.
 Use fundamental industry and sector analysis to determine allocations to sectors relative to
the index’s sector allocation.
 Use fundamental stock analysis to evaluate companies and identify underpirced and
overpriced stocks for buy and sell decisions.
Macro Analysis
In addition to using macroeconomic analysis to determine the allocation to styles and sub-styles,
fund manager also would use such analysis to determine how a specific industry relates to the
business cycle and what general economic variables influence the industry.
As a general approach, fund managers would identify key economic indicators that are indicative
of the broader economy. Operationally, a manager (or team of managers) would be responsible
for monitoring and assessing two to three economic indicators. From this analysis, managers
would try to identify a broad direction of the economy and potentially identify specific sectors
that may capitalize on the present trends. In their broad market assessment, some of the factors
and relations managers would need to identify would be:
Broad Economic Market Factors and Relations to Identify
Indicators:
 Leading and lagging economic indicators
 Consumer confidence, consumer spending, interest rate movements, inventory reports,
manufacturing sales, retail sales, and new home construction
Identification:
 Identify how indicators relate to specific sectors
 Identify key demographic tends: baby boomers, discretionary income of teenagers,
health initiatives, and working parents
 Identify what markets and sectors can capitalize on current market conditions
 Determine how different sectors would be affected if the economic expectations are
realized
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Sector/Industry Analysis
Sector/industry analysis is the next step in a top-down, three-step approach to fundamental stock
analysis. Such analysis is important if there are differences in the performances among different
industries. If the aggregate stock market, for example, is expected to generate a 12% rate of
return, while the return amongst all industries only ranges between 11% and 13%, then there
would not be much purpose in conducting an industry analysis: one could get a 12% expected
return by just randomly selecting industries. Studies of industrial performance, though, do show
a wide dispersion in the rates of return among industries.4 Ultimately, fund managers will need
to develop methodologies for finding the right stocks. It is easier, though, to find a good
company and stock from a good industry, than to find a good company and stock from a bad or
declining industry.
In evaluating sectors, fund managers would be responsible for evaluating each of the 10 sectors,
as well each sub-sector and industry. Operationally, fund managers, either individually or as a
team, would analyze assigned sectors using both quantitative and qualitative analysis. Each
manager or team would develop an expertise in their assigned sector. They would know (1) the
nature of each industry in terms of its current stage of development and its interrelationship with
other industries in the economy; (2) the relationship of the industry to the overall economy; (3)
how the broad market trends relate to different industries. Managers would also need to do
industry analysis to identify important competitive forces: rivalries among existing competitors,
threat of new entrants, barriers to entry, threat of substitute products, bargaining power of buyers,
and bargaining power of suppliers. This analysis would be used as inputs in conducting firm
analysis. Some of the key factors that managers would consider in their sector/industry
assessment include:
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Sector/Industry Analysis
Factors to Consider and Relations to Identify
Identification of sector trends
o Rationalizing the trend: Are the trends due to consumer behavior? Is the
industry vulnerable to broader economic influences?
o Research sectors using Bloomberg, Compustat, and other resources to
analyze sector trends
o Complete a SWOT of the entire sector
o Determine if the fund should overweight or underweight the sector
Identification of subsectors that provide the most opportunities
Identification of competitive advantages through subsectors
o Supply – proprietary technology and privileged access to resources
o Demand - high switching costs and customer captivity
o Economies of Scale – cost/unit decline as volume increases
Identification of subsectors that have the most upside potential.
In 1995, for example, the S&P 500 increased 37.6%, with the performances among industries
ranging from -15% (trucking industry) to 80% (biotech).
4
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Firm Analysis
The final step is to conduct fundamental stock analysis. Operationally, fund managers would be
responsible for evaluating each of the stocks in their sector. In forming the fund, the initial
decisions would involve selecting the stocks for the fund. Once the fund is constructed, the
analysis would involve evaluating stocks (held and not held). Managers would recommend:
 Holding or selling a currently held stock
 Increasing or decreasing the stock’s allocation
 Adding a new stock to the portfolio
 Swapping a new stock for a current stock in the portfolio
 Determining the timing of the buy, sell, or swap decision
In conducting fundamental analysis, managers would use both quantitative and qualitative
analysis to determine whether a stock is underpriced or overpriced. They would also be
responsible for timing decisions and would therefore have to use some technical analysis.
Quantitative methods managers would use include: performance ranking and valuation using the
multiplier and discounted cash flow models. Qualitative analysis would include: SWOT analysis
to identify a company’s strengths, weaknesses, opportunities and threats; identification of a
firm’s competitive strategies (e.g., low cost leadership or product differentiation); determination
of whether the business has a favorable long-term prospect and if it is sustainable; and
management considerations.
Performance Ranking: In conducting fundamental analysis, stocks within sectors can be ranked
by different criterion. While performance ranking does not identify mispriced stocks, it can
provide information about leaders in each sector. For example, managers could filter the growth
and value stocks from the pure growth and pure value indices based on the following criteria:
Growth Selection Criteria
Value Selection Criteria:
 Sales growth rate
 Price-to-book ratio
 EPS growth rate
 Price-to-sales ratio
 Sustainable growth rate
 Dividend yield
14
Multiplier Approach: The multiplier approach involves estimating the stock's price-to-earnings
ratio and its expected earning next year to determine its value. A company’s expected earnings per
share could be projected by estimating a company’s sales per share (S), operating profit margin
(m = EBDIT/S), depreciation per share (D), interest expenses per share (I), and effective tax rate
(t):
EBDIT = m S
EPSi = (EBDIT - D - I)(1 - t)
Forecasting a stock’s P/e could be based on comparing its P/e to those of the industry,
comparable firms, and the market. A second approach could be to estimate the firm’s P/e by
forecasting its retention rate (d/e), required rate (k), and growth rate (g):5
P
d/e

e k g
For example, applying the multiplier analysis to value Coach (one of the stocks in the Consumer
Cyclical Growth sector), an expected value of $52.79 was estimated (see Appendix A for details
on the data used in estimating the Coach’s value):
Estimated Price of Coach Using Multiplier Approach
Net Profit Margin
Sales Estimate (in mill)
Common shares o/s
EPS Estimate
Est P/E
Price Est
2008 Estimate
26%
3147
372
2.20
24.00
52.79
2007
25.50%
2589
375
1.76
Note: Coach’s estimated price was not significant different than the market price of Coach at the
time of this analysis. If this were the only consideration, fund managers would then reach a
conclusion that the stock is not underpriced and therefore should not be included in the portfolio.
k could be estimated using the CAPM: estimating Rf, the market risk premium, and the stock’'s
beta. Bloomberg also provides estimates of required returns. The company’s expected growth
rate in earnings could be determined by estimating the company’s retention rate and ROE, with
the estimated ROE determined by forecasting the company's net profit margin, asset turnover
ratio, and liquidity ratio. This information can be access from Bloomberg.
5
15
In trying to determine a stock’s intrinsic value using a multiplier approach, fund managers would
have to determine the important factors determining sales, operating profit margins, returns on
investments, and market risk. The multiplier approach, in turn, integrates these factors to
determine a stock’s value. As such, this approach provides a useful methodology for analyzing
companies. It can also be applied to industries and to the overall market.
Discounted Cash Flow Model: The multiplier approach is a popular method used by analysts to
estimate a stock's value. Recently, more fundamentalists have been using Discounted Cash Flow
(DCF) models to identify mispriced stocks. DCF models are more applicable for companies in new
industries in which different growth rate are expected. Most of these analysts incorporate one of the
several DCF growth models to estimate the value or rate of return on the stock they are evaluating.
Qualitative Analysis: Qualitative analysis complements the quantitative assessment of a
company. In conducting such analysis, managers would need to conduct the following type of
assessment:
Qualitative Assessment
 Compare and contrast companies in an identified subsector.
 Compare financial ratios and trends within a specified subgroup/subsector
 Rationalize the numbers from quantitative analysis using the economic, sector and
individual company’s qualitative analysis.
 Determine:
o Why did revenues increase?
o What is affecting profit margins?
o What capital investments will the company have to make to maintain their
competitive advantage?
 Determine if recent successes were an anomaly.
 Determine if a company can repeat or improve its performance given current sector and
economic conditions.
 Determine if the company’s competitive advantages is still extant.
 Determine the company’s competitive advantages:
o Supply – proprietary technology and privileged access to resources
o Demand - high switching costs and customer captivity
o Economies of Scale – cost/unit decline as volume increases
 Develop a SWOT:
o Use Annual Reports, financial ratios and other resources for strengths and
weaknesses
o Use information gained from economic and sector analysis for opportunities
and threats
16
Note: Bottom-up and Top-Down
A top-down, three-step approach can be viewed as a sequential process: first analyzing the
economy, then assessing sectors, and finally analyzing companies. In practice, though, fund
managers would be analyzing the economy, sectors, and companies simultaneously. As a result,
decisions by the managers could be based in some cases on firm factors, while in other cases the
decisions could be made on sector or overall economic considerations. The top-down approach
does ensure that in making a stock decision the interdependency between the overall economy,
sectors, and companies is considered.
4. PORTFOLIO
Initial Portfolio
If the above approach were implemented to form an equity fund, fund managers would initially
construct a portfolio with the following features:
 A value/growth fund managed against the S&P 500 index
 Approximately 40 value and growth stocks
 The proportions of the fund allocated to value stocks and growth stocks would be
determined by market expectations. A neutral position would reflect the proportions of value
and growth making up the index.
 The stocks selected would be based, in part, on sector analysis. Stocks in a sector expected
to be strong would have a greater allocation than that sector’s allocation to the index.
 Stocks selected from sectors would be those that have good fundamentals and are considered
to be underpriced.
Evaluation of the Portfolio
Once the portfolio is constructed, fund managers would be responsible for evaluating the overall
portfolio relative to the index. Bloomberg’s portfolio functions (PRTU) do provide analytical
and descriptive programs that can be used to evaluate the attributes of the portfolio relative to the
index. Managers can also apply various models, such as the Wells Fargo Evaluation System, to
assess whether or not the stocks in the portfolio are underpriced or overpriced. Similarly, to
evaluate the portfolio’s return sensitivity to various economic variables (e.g., investor’s
confidence, interest rate, and business fluctuations) managers can use models such as the Risk
Attributes Model (RAM) to assess the portfolio’s sensitivity (see Appendix B).
17
5. SIMULATED PORTFOLIO
As a first step in developing the proposed index portfolio, the Equity Fund Task Force
constructed a 40-stock portfolio. The stocks in the portfolio came from the stocks comprising the
pure value and pure growth style indices and were selected based on a screening and ranking
approach. Note: the stocks were not selected based on detailed economic, industry and firm
analysis.
Portfolio Construction
The method used to construct the portfolio consisted of nine steps:
1. Step 1: The Investment Universe: The portfolio was limited to the stocks comprising the
S&P 500.
2. Step 2: Investment Styles –Growth and Value: The pure style indices were used to
segregate stocks into the growth and value styles. As noted, the S&P U.S. index series
measures growth and value in separate dimensions across seven factors at the stock level.
These factors are standardized, and then used to calculate growth and value style scores for
each constituent. The Pure Style index Series consists of those stocks in the style series that
exhibit only strong growth or value characteristics. Using the style indices, the S&P 500
stocks were reduced to 192 stocks consisting of 151 growth stocks and 141 value stocks
Characteristic
Pure Style Index Series
Universal Coverage
Only Pure Style Stocks are included
Overlapping Stocks in Growth and
Value
Stocks are identified as either Pure Growth
or Pure Value
Weight
Stocks are weighted by Style Scores
Breadth
Narrower Coverage
Annual Turnover
Higher. Comparable to Pure Style Index.
Style Index
S&P 500/Citigroup Pure Growth
Number of Stocks
151
S&P 500/Citigroup Pure Value
141
Total
292
18
3. Step 3:Sectorwise Allocation: The 192 stocks were classified into 10 sectors (based on
Bloomberg’s Classification) for each style:
1. Basic Materials
6. Energy
2. Communications
7. Industrial
3. Consumer Cyclical
8. Technology
4. Consumer Non Cyclical
9. Healthcare
5. Financial
10. Utilities
4. Step 4: Industrywise Allocation: Each sector was further classified into industry groups for
each style. For example, in the list of pure growth stocks, 28 stocks belong to the sector
“Consumer Cyclical”. This sector was further classified into industry groups (e.g., apparel,
home furnishings, and Retail).
Ticker
Name
Apparel, Accessories & Luxury
RL
POLO RALPH LAUREN CORP
LIZ
LIZ CLAIBORNE INC
COH
COACH INC
Consumer Electronics
HAR
HARMAN INTERNATIONAL
Restaurants
DRI
DARDEN RESTAURANTS INC
SBUX
STARBUCKS CORP
YUM
YUM! BRANDS INC
Industry Sector
Industry Group
Consumer, Cyclical
Consumer, Cyclical
Consumer, Cyclical
Apparel
Apparel
Apparel
Consumer, Cyclical
Home Furnishings
Consumer, Cyclical
Consumer, Cyclical
Consumer, Cyclical
Retail
Retail
Retail
5. Step 5: Stocks Ranked in each Industry Group: For each style, the stocks in each industry
were ranked: Value/Industry and Growth/Industry. The rankings were based on the following
factors for each style:
Growth Factors
1.
2.
3.
4.
Sales: 5-year average growth
EPS: 5-year average growth
ROE
EPS: 5-year average growth
Value Factors
1.
2.
3.
4.
19
Price to Book
Price to Sales
Price to Cash Flow
Price to Earnings
6. Step 6: Filtering the Growth and Value Stocks: In each industry group, stocks were ranked
based on the growth or value factors. Based on industry rankings, the 292 stocks were
filtered down into 82 stocks: the 151 stocks in the growth group were filtered into 41 stocks
and the 141 stocks in value group were filtered down to 41 stocks. This filtering led to the
following breakdown (Column 2) for the each of the 10 sectors:
Sectors to be reallocated
1
Basic Materials
Communications
Consumer Cyclical
Consumer Non Cyclical
Energy
Industrial
Utilities
Healthcare
Financial
Technology
2
Current
Growth
Value
1
4
4
4
8
2
6
4
6
3
4
2
0
6
5
1
2
14
5
1
41
41
3
Required
Growth
Value
1
1
1
1
2
2
2
2
3
2
2
2
0
1
3
1
2
6
5
1
21
19
7. Step 7: Sector Rankings: Given the value and growth stocks making up each of the 10
sectors, the stocks in each sector were then ranked (irrespective of their style) based on
operating profit margin, return on capital (compared to WACC), YOY sales, P/E and EPS
growth. The stock rankings by sectors were used to reduce the size of the portfolio from 82 to
40. This actual stocks selected were determined once each sector’s allocation was
determined.
8. Step 8: Neutralize Portfolio: Given the 82 stocks and their break down by sector, style, and
sector ranking, the portfolio was then broken-down into a 40 stock portfolio, with the sector
allocations determined for a neutral value/growth position. To achieve this, the proportions
allocated to each sector were based on the sector’s allocation in the S&P 500. For example,
based on the filtering, the Consumer Cyclical Sector consisted of 10 stocks: 8 growth stocks
and 2 value stocks. This sector, in turn, represents approximately 10% of the S&P 500. To
ensure this proportion of a 40-stock portfolio, four stocks were selected from this sector
based on the stock’s sector ranking; in this case it was 2 value stocks and 2 growth stocks.
9. Stock Allocations: The Equity-Fund Team assumed a total fund value of $1,000,000. Given
this, the dollar investment in each sector’s was determined by the sector’s allocation to the
S&P 500. For example, given the consumer cyclical sector represents approximately 10% of
the S&P 500, approximately $100,000 was assumed to be invested in that sector. With that
sector filtered down to four stocks, approximately $25,000 was invested in each of the stocks
in that sector. For example, Coach was one of the four stocks included in that sector because
20
of it relatively high ranking. Given it stock price of $35.79 at the time of the simulation and
an actual allocation of $24,051, 672 shares of Coach were assumed to be purchased. Exhibit
4 lists the 41 stock making up the portfolio
Relative Performance of the Simulated Portfolio
After constructing the portfolio, the portfolio’s total returns were compared to the S&P 500’s
returns from November 2002 to November 2007 using Bloomberg’s back-testing program. The
comparative returns are shown in Figure 1. As shown, the simulated portfolio outperformed the
index over the 5-year period.
Figure 1: Historical Performance of Simulated Portfolio Relative to the Index
21
Exhibit 4: Stocks Comprising the Simulated Portfolio
Number
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
Stock
ABC US
ADSK US
ALL US
AXP US
CHK US
CNP US
COF US
COH US
COL US
COP US
CSCO US
CTSH US
EDS US
FCX US
GOOG US
IBM US
JPM US
MCK US
MDT US
MRO US
NE US
NUE US
NVDA US
ORCL US
PCAR US
PEP US
PG US
PNC US
PTV US
SBUX US
SRE US
SVU US
SWK US
SYK US
TRV US
UNH US
WB US
WFC US
WHR US
WMI US
XOM US
Number of Shares
647
581
471
422
612
974
467
672
390
296
626
859
1365
161
30
257
575
356
636
406
458
308
831
1296
490
321
325
356
1157
996
286
595
559
416
470
545
633
796
303
852
275
22
Market Price
44.56
47.46
51.27
56.89
37.99
17.6
51.92
35.79
73.68
78.82
28.15
31.57
20.36
96.65
697
107.5
43.65
66.52
50.29
55.31
52.37
57.41
33.12
20.48
50.43
76.54
74.15
72.34
24.86
23.04
62.26
42.26
51.42
72.23
52.29
54.76
41.25
30.54
79.35
33.76
88.59
Market Value
28.830M
27.574M
24.148M
24.008M
23.250M
17.142M
24.247M
24.051M
28.735M
23.331M
17.622M
27.119M
27.791M
15.561M
20.910M
27.628M
25.099M
23.681M
31.984M
22.456M
23.985M
17.682M
27.523M
26.542M
24.711M
24.569M
24.099M
25.753M
28.763M
22.948M
17.806M
25.145M
28.744M
30.048M
24.576M
29.844M
26.111M
24.310M
24.043M
28.764M
24.362M
6. MANAGING THE EQUITY FUND
WITH THE FIXED-INCOME FUND
Student Investment Fund Center
There may be certain benefits from combining some of the operations of an equity fund with the
current fixed-income fund. To achieve this, the Equity-Fund Task Force recommends that if an
equity fund is created that consideration be given to the creation of a Student Investment Fund
Center. The Center would initially consist of the XSIF Fixed-Income Fund, the proposed Equity
Fund, a Research Center, and a Public Relations Center. The Research Center would conduct
macro and industry analysis as requested by the equity and fixed-income fund managers and
examine new investment strategies. Organizationally, the Student Investment Fund Center could
be managed either by a Fund Professor/Director assisted by a Center Director or by a Center
Director with a Fund Professor/ Director for each fund. Similarly, a Board of Directors could be
set up for the Center that would be responsible for both funds or alternatively separate boards
could be set up to oversea each fund.
Student
Investment
Fund Center
Center Professor
Center Director
Research Center
Fixed-Income
Fund
Proposed Funds
Equity Fund
Public Relations
Industry, country, and
economic, Analysis
Website
Management
New Portfolio
Construction
Newsletter
Investment Strategies
Bond Summit
23
Balanced Fund
There may also be certain synergies from combining an equity fund with the current fixedincome fund. As an investment management strategy, the two funds could be combined to form a
balanced equity, bond, and money market fund. This would require that the fund managers
develop an expertise in equity/bond asset-allocation decisions and in equity/bond tactical asset
allocation strategies. If the funds were combined, the managers for the equity portion of the fund
would be able to make better timing decisions on their investments. In turn, the managers of the
fixed-income portion could better justify the current fixed income fund’s enhance index
management strategy given that there would be possible asset re-allocation decisions. Finally,
both the equity and bond fund managers would be able to make return-risk preference decisions
based on the different return-risk opportunities obtained from different equity-bond allocations.
If the funds were combined, limits would need to be determined on the allocations to equity and
bonds. As a practical matter, consideration of a combined fund could only be made once an
equity fund is set up and the operational structure for managing both funds has been put in place.
Resources
The management of an equity fund would require at least eight students. If the current
MBA/undergraduate arrangement for the fixed-income fund were used, then there would be
eight undergraduates managing the fund from October to May and eight MBAs managing it from
May to October. For the bond and equity funds to operate, more resources would be needed.
These would include:
 Physical Space
 Computers.
 Bloomberg Terminals (1 or 2 additional terminals)
 Additional Finance Technologies:
o FactSet
o Morningstar
o Thomson
o MultexNet/Reuters

Travel Funds

Annual Meeting Funds
24
7. FORMATION OF THE FUND
To set up the equity fund, the XSIF Equity Fund Task Force proposes that a Student Equity Fund
Team and a Student Equity Fund Task Force be formed.
Student Equity Fund Team
The Student Equity Fund Team would be responsible for setting up the initial fund. They would
also be responsible for developing the operational structure needed to manage the fund. The team
would consist of:





4 to 5 current XSIF fund managers
2 to 3 MBA fund managers
3 to 4 finance majors (preferably juniors) nominated by the Department of Finance
3 to 4 MBA students concentrating in Finance nominated by the Department of finance
XSIF Fund Professor
The Student Equity Fund Team would be responsible for setting up an initial fund based on the
index fund described in this report.
Team Format
The students would be divided into five subgroups. Each group would be responsible for
analyzing two sectors from the 10 sectors: Consumer Discretionary, Telecommunications,
Healthcare, Energy, Financial, Utilities, Consumer Staples, Industrials, Information Technology
and Basic Materials.
Top-Down Approach
The Economy: Each group would be responsible for one or two economic indicators (e.g., GDP,
consumer confidence, consumer sentiment, and the like).
Sectors: After an analysis of the broader economy, each group would evaluate their individual
sectors. Each group would determine an “underweight” or “overweight” rating for their sector
relative to that sector’s allocation in the S&P 500. The equity fund team would then vote on the
offerings.
Securities: After setting the weights for each industry, members of each team would be assigned
stocks in their sectors. Every member would be responsible for ranking the stocks in the sector
and conducting quantitative and qualitative analysis of their stocks. Each member would present
their respective securities and offer a buy, possible buy, or no buy recommendation.
25
Portfolio Constructed
Once the stocks representing the index are selected, the equity-fund team would determine the
final allocations of each stock. The team would then evaluate the portfolio in terms of its
attributes, historical performance, and sensitivity to different factors.
Equity Fund Task Force
The Equity Fund Task Force would be responsible for providing advice to the Student Equity
Fund Team and making recommendations on the fund’s overall structure, by-laws, and
management. This would include recommendations on:





Whether the fund should be part or separate from the fixed-income fund
The structure of the Board of Directors
The MBA and undergraduate arrangement for the management of the fund
Trading and custodial arrangements
Academic credits
The task force would consist of:





2 to 3 members of the Finance Department
3 to 4 members of the XSIF Board
Persons nominated by the XSIF Board
A member of the Board of Trustees or a person or persons nominated by the Board
XSIF Fund Professor
Time Table and Tasks
The XSIF Fund Task Force recommends the following time table and tasks:
 March 1, 2008: The Equity Fund Team would be expected to complete its portfolio
construction. It would present a report to the Equity-Fund Task Force and the Department of
Finance.
 March 10, 2008: Equity-Fund Task Force would evaluate the portfolio and make its
recommendations. It would then submit a report to the XSIF Board.
 March 15, 2008: Special meeting of the XSIF Board to evaluate the recommendations of the
Equity Fund Task Force and Equity Fund Team. The XSIF Board would then make a
recommendation to the Department of Finance on the proposed equity fund.
 April 1, 2008: The Department of Finance would submit its recommendation to the Finance
Subcommittee of the Board of Trustees.
26
 April 15, 2008: If approved, the Department of Finance would begin selecting students to
manage the fund.
 June 15, 2008 or September 1 2008: XSIF Fund Managers would begin managing the fund.
The actual date would depend on the decision made on the type of MBA and undergraduate
management structure recommended for the fund.
27
APPENDIX A
FUNDAMENTAL ANALYSIS OF COACH USING MULTIPLIER APPROACH
COACH Price Estimate
Net Profit Margin
Sales Estimate (in mill)
Common shares o/s
EPS Estimate
Est P/E
Price Est
2008 Estimate
26%
3147
372
2.20
24.00
52.79
2007
25.50%
2589
375
1.76
Data used for Analysis
Sales
Cost of Sales
Gross Profit
SG&A
Operating Profit
Operating Profit Margin
2007
2612000000
589000000
2023000000
1030000000
993000000
38.02%
2006
2005
2004
2003
2002
2035000000 1652000000 1321000000 952000000 719000000
454000000 384000000 331000000 276000000 236000000
1581000000 1268000000 990000000 676000000 483000000
867000000 732000000 585000000 434000000 362000000
714000000 536000000 405000000 242000000 121000000
35.09%
32.45%
30.66%
25.42%
16.83%
28
Retail Stores (NA)
% increase YOY
Retail square footage
% increase YOY
Factory stores
% increase YOY
Japan Locations
% increase YOY
Retail Locations (Japan and NA)
2007
259
18.81%
672737
19.59%
93
8.14%
137
16.10%
396
2006
218
12.95%
562553
14.59%
86
4.88%
118
14.56%
336
2005
193
10.92%
490925
13.74%
82
7.89%
103
3.00%
296
2004
174
11.54%
431617
18.80%
76
0.00%
100
7.53%
274
2003
156
13.04%
363310
20.50%
76
2.70%
93
9.41%
249
%change
%change Sales-Retailstores
45.00%
40.00%
35.00%
30.00%
% change is sales
25.00%
20.00%
% change in retail
stores
15.00%
10.00%
5.00%
0.00%
2001 2002
2003 2004 2005
Year
29
2006 2007
2002
138
14.05%
301501
74
85
223
Date:
Change Period To Date Percent
Sales/Revenue/Turnover
Cost of Goods Sold/F.E.& P.P.&G.
SG&A / Oth Op / Dep Op & Maint
Operating Income (Losses)
Interest Expense
Net Income/Net Profit (Losses)
Earnings Per Share
Depreciation Expenses
EBIT(Earn Bef Int & Tax)
EBITDA(Earn Bef Int Dep & Amo)
Changes in Working Capital
Book Value per Share
Capital Expenditures
Retail - Num of Locations (End)
Operating Margin
Profit Margin
EBIT Margin
Dividend Payout Ratio
Asset Turnover
Inventory Turnover
5 Year Average Return On Equity
Return On Capital Employed
Return on Assets
Return on Common Equity
Financial Leverage
Interest Expense Coverage
Retention Ratio
Sustainable Growth Rate
#N/A Flds
58.495
2612.456
589.47
1029.589
993.397
#N/A N.A.
663.665
1.8
#N/A N.A.
993.397
1074.284
699.542
5.1282
-140.872
489
38.0254
25.4039
38.0254
0
1.2819
2.2469
42.3697
50.4333
32.5643
42.8297
1.3152
#N/A N.A.
100
42.8297
FY1 2006
-10.8793
2035.085
453.518
866.86
714.707
#N/A N.A.
494.277
1.3
#N/A N.A.
714.707
779.822
188.959
3.2143
-133.876
422
35.1193
24.2878
35.1193
0
1.3582
2.1704
42.2044
62.6163
32.9883
44.0404
1.335
#N/A N.A.
100
44.0404
FY1 2005
45.5847
1710.423
399.652
738.208
572.563
#N/A N.A.
358.612
0.95
#N/A N.A.
572.563
622.963
-91.685
2.7903
-94.592
378
33.4749
20.9663
33.4749
0
1.4167
2.3079
40.4887
55.2617
29.7039
39.0176
1.3136
#N/A N.A.
100
39.0176
FY1 2004
84.5815
1321.106
331.024
545.617
444.465
0.808
261.748
0.7
#N/A N.A.
444.465
488.975
248.307
2.0628
-73.659
#N/A N.A.
33.6434
19.8128
33.6434
0
1.5897
2.1655
36.3973
50.7186
31.4965
43.2922
1.3745
519.3029
100
43.2922
FY1 2003
81.9308
953.226
275.797
433.667
243.762
0.695
146.628
0.41
#N/A N.A.
243.762
275.112
158.917
1.1664
-61.857
#N/A N.A.
25.5723
15.3823
25.5723
0
1.8016
1.9685
29.4531
49.5453
27.7121
42.6688
1.5397
335.8845
100
42.6688
FY1 2002
44.2838
719.403
236.041
346.354
137.008
1.124
85.827
0.2425
#N/A N.A.
137.008
162.502
81.041
0.7276
-42.764
#N/A N.A.
19.0447
11.9303
19.0447
0
2.0575
1.9543
#N/A N.A.
51.2843
24.5472
42.0031
1.7111
119.3726
100
42.0031
FY1 2001
#N/A N.A.
600.491
218.507
275.727
106.257
2.563
64.03
0.195
#N/A N.A.
106.257
130.388
-6.97
0.4244
-31.868
#N/A N.A.
17.695
10.6629
17.695
0
2.1625
2.1085
#N/A N.A.
55.0134
23.0588
35.4617
1.5379
39.7944
100
35.4617
Profitability
Ratios
Company
Industry
Sector
S&P 500
Gross Margin
(TTM)
77.44
53.98
33.33
44.29
Gross Margin - 5
Yr. Avg.
76.28
51.96
33.04
44.05
EBITD Margin
(TTM)
41.12
21.89
12.86
22.96
EBITD - 5 Yr. Avg.
36.85
19.95
12.52
21.35
Operating Margin
(TTM)
38.03
19.34
10.2
19.68
Operating Margin 5 Yr. Avg.
33.74
18.09
9.35
19.21
Net Profit Margin
(TTM)
24.37
11.77
6.52
13.64
Net Profit Margin 5 Yr. Avg.
21.71
11.69
5.82
12.45
Effective Tax Rate
(TTM)
38.48
35.77
31.84
29.97
30
FY1 2000
#N/A N.A.
548.918
220.085
272.816
56.017
0.42
38.603
0.1375
#N/A N.A.
56.017
78.645
2.404
0.7595
-26.06
#N/A N.A.
10.205
7.0326
10.205
0
1.8969
2.1631
#N/A N.A.
33.514
13.3403
18.5605
1.3913
133.4524
100
18.5605
FY1 1999
#N/A N.A.
507.781
226.19
255.008
26.583
0.441
16.715
0.06
21.339
26.583
48.839
-43.869
#N/A N.A.
-13.519
#N/A N.A.
5.2351
3.2918
5.2351
0
1.8814
1.9349
#N/A N.A.
12.0954
6.1931
8.5713
1.384
44.2222
100
8.5713
FY1 1998
#N/A N.A.
522.22
235.512
261.695
25.013
0.508
20.663
#N/A N.A.
21.571
25.013
47.797
#N/A N.A.
#N/A N.A.
-15.178
#N/A N.A.
4.7897
3.9568
4.7897
0
#N/A N.A.
#N/A N.A.
#N/A N.A.
#N/A N.A.
#N/A N.A.
#N/A N.A.
#N/A N.A.
49.9299
100
#N/A N.A.
Risk-Free Rate
Beta (Bloomberg)
Equity risk premium
k
g
31
4.41%
1.31
0.0711
13.72%
42.83%
APPENDIX B
RISK-ATTRIBUTES MODEL – RAM
RAM Model
Step 1: Stock returns are explained by a set of macroeconomc variables.
Variable
1. Investors’ Confidence
RAM
1. RCorp – Rgovt
2. Interest Rates
2. (LT Rate – ST Rate)
3. Inflation Shock
3. Actual minus expected inflation rate
4. Aggregate Business Fluctuations
4.  (Industrial Production)
5. Foreign Variables
5. (Exchange Rate)
6. Market Factors
6. Residual Market Beta
Step 2: Run a time-series regression of the stock returns against the six macroeconomic variables.
For example, do a regression of the returns of the stocks making up the index against the above
macroeconomic factors.
ri  a i  bi1F1  bi 2 F2      bi 6 F6  i
Step 3: Standardize the coefficients. For each coefficient, calculate the average coefficient and
average standard deviation.
3500
b1 
b
i 1
i1
3500
and  b1
 3500
2
  (b i1  b1 ) 

  i 1
3500




1/ 2
Next, for stock i measure the adjusted standardized coefficient as:
b̂i1 
bi1  bi
 b1
32
Interpretation:
• If adjusted b = 0  Stock’s sensitivity to factor 1 is no different than the average.
• If adjusted b > 0  Above average responsiveness to factor 1.
• If adjusted b < 0  Below average responsiveness to factor 1.
Step 4: For each stock determine its score, Si. The score is obtained by multiplying the stock’s
adjusted coefficients by an estimate of the macroeconomic factors, then summing the products.
Si  a i  b̂i1 (E(F1 ))  b̂i 2 (E(F2 ))      b̂i 6 (E(F6 ))
Step 5: Construct a portfolio with the highest score.
Alternative: Construct different portfolios based on the portfolio’s sensitivity to different economic
scenarios, then select the best.
33