Investment Analysis of Allied group

The paper analyzes a stock that Allied group wants to invest in. The important information used to make the investment decision is the stock average returns, the risk as measured by standard deviation and the portfolio returns.

Table One: Earnings from 1990 to 2010

Year

Earnings

1990

-8%

1995

23%

2000

26%

2005

31%

2010

18%

Average Return for the Stock over the five years

Average = Total Sum/ Number of years

Total Sum = -8+23+26+31+18 = 90%

Number of years = 5

Average return = 90%/5 = 18%

Standard Deviation of Stock over the period

Standard Deviation = √Sum (X- x̅)2 / N

Where X is the individual return,

x̅ is the mean of the five-year stock returns

N is the number of years

The Standard Deviation shows the volatility or risk associated with a stock. The formula indicates that the standard deviation is the square root of the total variance of returns (Adam, Marcet & Nicolini).

Table two: Calculation of the Standard Deviation

Year

Earnings

(X- x̅) where x̅=18%

(X- x̅)2

1990

-8%

-26%

6.76

1995

23%

5%

0.25

2000

26%

8%

0.64

2005

31%

13%

1.69

2010

18%

0%

0

Sum ((X- x̅)2) = 9.34

Standard Deviation =√9.34/5) = 13.67%

Assuming the stock is added to a portfolio earning returns of 19.5%

If the first Stock (A) has an average return of 18% and a stock (B) has an average return of 19.5%, the average return of the portfolio would be:

½ (18% +19.5%) = 18.75%

Adding the stock to the portfolio reduces the average return from 19.5% to 18.75% because the stock has a lower average return compared to that of the portfolio.

Making Decision to invest in the stock

The Allied company should invest in the stock because of two reasons. First, the stock earns a high return of 18% which is closer to the current portfolio return of 19.5% meaning that the reward can cover for the risks associated with stock diversification. For example, if the company decides to invest in the stock, it can be concluded that it will earn the average return of 18% even if the portfolio average declines because the stock price is not affected by the prices of other stocks in the portfolio. Secondly, the stock has a relatively lower volatility of 13.67% shown by the standard deviation which means that the stock has a lower risk than reward. The balance between risk and reward is important in stock investment because the stock market prices change over time. However, an investor should cure the risks associated with stock investment through diversification which implies that there should be many unrelated stocks in the investor’s portfolio (Syriopoulos, Makram & Boubaker 2015).

However, Allied investment should consider many factors other than the current stock average of rewards and the risks involved (Kang, Ratti& Yoon, 2015). First, the company should consider that there are many investors trading in the stock and that these investors are involved in the analysis of and valuation of stocks for profit. Secondly, the Allied company should invest in the stock if the prices adjust quickly to the available information and that other investors do not have private information which they use to increase their returns over and above the rest of the traders. Besides, the stock price should reflect all the available information. Finally, the Allied company should invest in the stock if the information affecting the stock prices come to the market randomly and independently. These factors determine the efficiency of the stock market.

Conclusion

The Allied company should invest in the stock because it has a higher reward than risk. Besides, adding the stock with a reward of 18% to the portfolio of 19.5% does not amount to losses because the variance between the stock’s reward and the earning of the portfolio are marginal.

References

Adam, K., Marcet, A., & Nicolini, J. P. (2016). Stock market volatility and learning. The Journal of Finance, 71(1), 33-82.

Kang, W., Ratti, R. A., & Yoon, K. H. (2015). The impact of oil price shocks on the stock market return and volatility relationship. Journal of International Financial Markets, Institutions, and Money, 34, 41-54.

Syriopoulos, T., Makram, B., & Boubaker, A. (2015). Stock market volatility spillovers and portfolio hedging: BRICS and the financial crisis. International Review of Financial Analysis, 39, 7-18.