Security Analysis and Portfolio Management

STOCK SELECTION

• The primary criteria for stock selection is market capitalization. For this purpose, only the large and medium sized stocks have been considered, keeping the Contrarian approach into consideration. As per Contrarian approach of stock selection only the large and medium sized companies should be focused upon for investment due to their reliability of financial statements as well as their greater visibility in the market. Accordingly, we have selected the top 25 companies with market capitalization of over INR 10 Billion.  

• Apart from market capitalization, the other criteria for stock selection are P/E and P/B ratios. For this purpose, the stocks with P/E and P/B ratios pertaining to the bottom 40% of the market have been considered. This selection criteria of selecting the bottom 40% stocks is in line with the Contrarian approach which targets the undervalued stocks. The reason for the same is that such undervalued stocks tend to outperform the market estimates as compared to the overvalued stocks.

• The 25 companies have been shortlisted using the Screener App in the Thompson Reuters database

• To shortlist the 6 companies out of 25 shortlisted ones, the Debt to Equity ratio and Current ratio have been taken into consideration. Based on Contrarian approach, a company’s strong financial position is one of the major areas of concern while investing and a low D/E ratio and high current ratio are indicators of the same. Accordingly, companies with D/E in the bottom 20% of the market and current ratio greater than 1.5% have been selected

• The companies that have been selected are Bajaj Holdings and Investment Ltd, HCL Technologies, NMDC Ltd, DB Corp, Sun Pharma and Rallis India Ltd. These fulfill the criteria mentioned above and hence an efficient frontier has been formed using them.

             EFFICIENT FRONTIER

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The efficient frontier is the set of all the optimal portfolios that offer the highest expected return for a given level of the risk. Portfolios that lie below the efficient frontier are sub optimal as they do not provide sufficient return for the given risk taken.

For an optimum portfolio the following criteria needs to be fulfilled:

• The Sharpe ratio should maximum
• The maximum Sharpe ratio is 0.096

Therefore, as can be seen in the above table the optimal portfolio return is 9.46% with a standard deviation of 31.19%. The weights associated from the optimal portfolio for the various constituents are as follows: