Maximizing Profit Through Strategic Stock Selection: A Comprehensive Approach

1. PICK SIX STOCKS Team 077 Naiim Ali Dennis Kim Jason Kornblum Franklin Tong Caleb Tseng 1

2. The Problem • To develop a way in which to select any combination of up to six stocks from among the 18 given • To maximize the net profit from after 1 year • To use the given stock indicators as well as one of our choice • To test and validate the results 2

3. Assumptions • In the course of the next fiscal year, the market will be generally rising. • All provided data are not subject to financial fraud, and therefore accurately represent the status of the company. • All eighteen corporations do not practice corporate manipulation, such as slush fund accounting. • The market will behave relatively normally, without unreasonably sharp increases or decreases. • Inflation will not create any exaggerated effects on the market. 3

4. Investment Philosophies • Value Investing • Targeting under-priced stocks with the assumption that they will eventually rise • “Buy and Hold” • Holding investments for long periods of time in the hopes of eventually reaching a peak due to normal market fluctuations • Contrarian Strategy • Evaluating based on mood of investors: optimism leads to falls, pessimism brings spikes • Overall market behavior is ignored in favor of analysis of the individual share 4

5. Indicating Factors • Cash Flow • Amounts of cash received or spent by a business • Price to Earnings (P/E) Ratio • Cost for each dollar of earnings • Return on Invested Capital • A lagging indicator of past performance 5

6. Indicating Factors • Price to Sales (P/S) Ratio • Used to determine how a company is faring relative to its competitors for start-ups, small cap companies, and unprofitable firms • Beta (β) • Determines the deviation between a stock price and the overall market 6

7. Discounted Cash Flow • DCF is a leading indicator, which predicts future behavior • DCF is the amount of money that one would pay today for the anticipated cash flow of the future. • DCF is the money of the future converted into the cash of the present with risk insurance in case cash disappears. • A factor such as the discounted cash flow is useful, as it helps to predict the future instead of only working off of the past, like the other five factors. 7

8. Our Financial Plan • Three risk groups, with a certain amount of money allotted to each group • Up to two stocks per risk group • Because every stock has a chance, however small, of dropping, investing in only one stock is extremely risky 8

9. Money Allotments per Group • Low • 50% of total funds ($15000) • Medium • 35% of total funds ($10500) • High • 15% of total funds ($4500) 9

10. Determining & Categorizing Risk • Cash Flow • As high as possible • Price to Earnings (P/E) ratio • As low as possible 10

11. Determining & Categorizing Risk • Return on Invested Capital • As high as possible • Price to Sales (P/S) Ratio • As low as possible • Beta • Close to 0 – no risk, not connected to market • Close to 1 – low risk • Above 1 – higher risk 11

12. Sample Individual Stock Evaluation • Appears to have already hit a peak, and is on the decline • Lowest cash flow at 0.10 • Low ROIC, only 16.88% • P/E is reasonable, 25.98, • P/S value is very low, 2.17. • During a period of steady growth overall for the market, MSCS was experiencing a net loss of 16.3%. 12

13. Sample Individual Stock Evaluation • Decent cash flow, 1.20 • The highest ROIC of all the companies, 30.76% • One of the highest net profits at 23.4% during the period of steady growth in the market, 2003-4 • P/E and P/S are also reasonable low, 19.11 and 6.06 respectively • Beta value is very close to one, 1.04, so it won’t experience that much change from the market 13

14. Building the JAVA Model • “Brute Force” Algorithm - Tries every combination of stocks until best permutation is found • Modeled after 2003-04 fiscal year • Represented a generally rising year • Maximizes profit while minimizing risk 14

15. JAVA Model MSFT: $10000 ORCL: $5000 Permutation Creator “Profit” Calculation for Permutation Permutation with Maximum “Profit” Comparison $2000 15

16. JAVA Model: Finer Points • Elimination of outlier stocks (ones with maximal loss or extreme instability) • A variable was introduced: • Cash Flow/Beta • We wanted to reward companies with greater stability while punishing greater risk: taking a linear relation with cash flow and inverse relation with beta accomplishes this goal 16

17. Results 17

18. Testing the Results • Testing other similar stable growth in past fiscal years and analyzing the data that is outputted • Check the performance of the results given by the model over the next fiscal year 18

19. Highlights • Identifying and utilizing a combination of Trend Analysis, Value Investing, and “Buy & Hold” strategies • Analysis of shares on an individual basis using the suggested indicators as well as 5-year graph and Discounted Cash Flow • Simultaneous production and testing of possible solutions using JAVA model • Understanding and using the fact that computer programs are best utilized in combination with human analysis 19