Monday, June 27, 2011

Finance Diversification

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Diversification


After looking at the cyclical nature of the communications equipment industry, it was clear that a company from an established industry was needed to diversify the wild swings in ANDW’s stock price. A year regression of ANDW stock performance revealed a beta of 1.8. This high beta signifies that ANDW is almost two times as volatile as the general market. A company with a much tamer beta is required to balance a portfolio of ANDW stock. After a thorough sector and industry analysis, Fresh Delmonte Products (FDP) was found to be a stable company in the Crops industry under the Consumer Non-Cyclical sector. FDP is a large producer and marketer of fruits and vegetables whose performance is dependent on global supply and of its produce. Thus, FDP is not as prone to economic and general business spending swings, like ANDW. FDP’s historic performance highlights it as a flight to safety in troubled economies. The chart to the right illustrates FDP’s performance versus ANDW during the last years.


To examine the diversification effects of adding FDP to an ANDW portfolio lets first look at the characteristics of a 100% ANDW portfolio. Based on the past three years of stock data, ANDW managed to loose .01% of its stock value. The risk of that return was measured with a standard deviation of 16.7% and with a beta of 1.84. When correlated with the market the R revealed that only 8.0% of the variation was tied to the market.


REGRESSION Std. Dev Beta R


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ANDW -1.68% 1.884 8.0%


FDP 50.0% 0.658 0.66%


50/50 Portfolio 18.6% 1.081 6.71%


The combination of FDP and ANDW stock in a 50/50 portfolio was effective in reducing some of the diversifiable risk associated with the individual stocks. The 50/50 portfolio gained 18.6% annually on average. The risk was reduced as noted by the lower standard deviation of 11.1% and beta of 1.08. When this portfolio was correlated against the S&P 500 the R suggested that only 6.71% of the variation was associated with the direction of the market. These results are illustrated in the table to the right.





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