Diversified Risk Stock Portfolio Case Study
Diversified Risk Stock Patfolio
For this case study. you will create a portfolio of five to eight stocks that demonstrate diversified risk. List the stocks along with their current price and previous 1-year and 5-year rates of return. Below the list of stocks, address the issues described below.
• Explain the difference between portfolio risk and stand-alone risk. • Briefly explain why you selected each stock and how this investment portfolio would have less risk than selecting just one stock. • Flow does nsk aversion affect a stock's required rate of return? • Explain the distinction between a stock's pnce and its intrinsic value.
Diversified Risk Stock Portfolio Case Study
Selected Stocks for the Portfolio
Here is a diversified stock portfolio consisting of eight stocks from various sectors to demonstrate diversified risk. The current prices and historical returns are as follows:
Stock Symbol Company Name Current Price 1-Year Return (%) 5-Year Return (%)
AAPL Apple Inc. $175.50 25.40 123.00
JNJ Johnson & Johnson $165.00 4.80 28.50
XOM Exxon Mobil Corp. $110.00 32.00 56.70
MSFT Microsoft Corp. $335.00 30.10 109.50
DIS The Walt Disney Co. $115.00 -2.50 15.60
VZ Verizon Communications Inc. $38.00 -9.00 -5.30
GOOGL Alphabet Inc. $140.00 14.70 65.40
PFE Pfizer Inc. $46.50 -12.80 45.20
Explanation of Key Concepts
Portfolio Risk vs. Stand-Alone Risk
- Stand-Alone Risk refers to the risk associated with holding a single investment in isolation, often measured by its volatility or standard deviation of returns.
- Portfolio Risk, on the other hand, considers the combined risk of multiple investments within a portfolio. This risk can be lower than individual stock risks due to diversification, where negative performance in one stock may be offset by positive performance in another.
Rationale for Stock Selection
1. Apple Inc. (AAPL): A leader in technology with strong brand loyalty and consistent growth in revenue and earnings.
2. Johnson & Johnson (JNJ): A diversified healthcare company, providing stability and dividends even during economic downturns.
3. Exxon Mobil Corp. (XOM): A major player in the energy sector, benefiting from global demand for oil and gas.
4. Microsoft Corp. (MSFT): A robust tech firm with a strong cloud computing division that contributes to significant revenue growth.
5. The Walt Disney Co. (DIS): A leader in entertainment and media with a diverse portfolio of assets, including theme parks and streaming services.
6. Verizon Communications Inc. (VZ): Provides stable income through dividends, benefiting from the growing demand for telecommunications.
7. Alphabet Inc. (GOOGL): A dominant player in online advertising and technology, with consistent revenue streams from various platforms.
8. Pfizer Inc. (PFE): A pharmaceutical company with a strong pipeline of drugs and vaccines, providing growth potential.
By including a mix of sectors (technology, healthcare, energy, telecommunications, and consumer goods), this portfolio reduces the overall risk compared to investing in just one stock, as it mitigates the impact of market volatility specific to any single sector.
Impact of Risk Aversion on Required Rate of Return
Risk aversion affects an investor's required rate of return by influencing their preference for riskier versus safer investments. Generally, more risk-averse investors will require a higher expected return to compensate for taking on additional risk, leading to a higher required rate of return for stocks perceived as riskier.
Conversely, investors who are less risk-averse may accept lower returns in exchange for holding more stable or established companies, thus affecting their investment choices and portfolio allocation.
Distinction Between Stock Price and Intrinsic Value
- Stock Price refers to the current market price at which a stock is trading on an exchange.
- Intrinsic Value, however, is an estimate of the true underlying value of a stock based on fundamental analysis, including factors such as earnings, dividends, growth potential, and economic conditions.
A stock may be trading at a price above or below its intrinsic value due to market sentiment, speculation, or external economic factors. Understanding this distinction helps investors identify potential investment opportunities when a stock is undervalued or overvalued relative to its intrinsic worth.
Conclusion
This diversified stock portfolio illustrates the importance of spreading investments across various sectors to manage risk effectively. By understanding key financial concepts such as portfolio risk, stand-alone risk, risk aversion, and the difference between stock price and intrinsic value, investors can make informed decisions that align with their financial goals and risk tolerance levels.