FIN 7100 Module 3 Risk and Return Interim Report Example

Four New Jersey Stocks, Sixty Months and One Portfolio: An Interim Report on Risk and Return for an Income-Seeking Client

Student Name

Master of Business Administration (MBA), Thomas Edison State University

FIN-7100: Financial Management

Mentor Name

Month Day, Year

Four New Jersey Stocks, Sixty Months and One Portfolio: An Interim Report on Risk and Return for an Income-Seeking Client

This interim report is the second stage of my final project, in which I act as an investment manager recommending stocks to a client. The client, a composite retired couple in Princeton, wants a sleeve of about $300,000 in large companies headquartered in New Jersey, with steady income and less volatility than the overall market. My approved proposal named four candidates: Johnson & Johnson and Merck in pharmaceuticals and medical technology, The Campbell's Company in packaged food, and Prudential Financial in insurance and asset management. Since the proposal, I have collected the price and dividend data, run the calculations and reviewed each company's latest annual report. This report sets out the data and method, presents the risk and return of each stock and of combined portfolios, and states a preliminary view. The final paper will add capital structure and the effects of market imperfections.

Data and Method

Monthly closing prices adjusted for dividends and splits were collected for each stock from September 2021 through September 2026, giving sixty monthly returns from October 2021 onward. The S&P 500 index served as the market; because the index series excludes dividends, the comparison slightly understates the market's total return. Following the textbook's treatment of historical risk and return (Berk & DeMarzo, 2020), I calculated each stock's average monthly return and standard deviation, both annualized, its beta from a regression on the index, its largest peak-to-trough decline and its Sharpe ratio, using the average three-month Treasury bill yield over the period, 3.77 percent, as the risk-free rate.

Results for Each Stock

The four stocks behaved very differently over the five years.

Merck delivered the highest average return, helped by strong sales of its cancer medicines, but also the highest volatility and a 40 percent fall from its peak before recovering. Johnson & Johnson combined a strong return with the lowest volatility and the shallowest decline of the four, which gives it the best fit with the clients' wish for steadiness. Campbell's lost money in most of the period and fell 59 percent from its high; its low beta did not protect investors, because almost all of its risk was specific to the company. Prudential behaved most like the market, with a beta of 0.85, and earned less than the index with more volatility.

The betas deserve caution. Three of the four are far below 1, partly because pharmaceutical and food stocks often move independently of the broader market and partly because company-specific events dominated these five years. Fama and French (1992) found that beta alone did a poor job of explaining differences in average returns across stocks, and these results are a small example: the lowest-beta stock earned the worst return and the two drug makers earned more than their betas would predict.

Correlations and Diversification

Markowitz (1952) showed that a portfolio's risk depends on how its holdings move together, not only on their individual volatility. The correlations among the four stocks were low, from 0.13 between Campbell's and Prudential to 0.49 between Johnson & Johnson and Merck, the only pair in the same industry. An equal-weighted portfolio of all four had an annual standard deviation of 14.8 percent, well below the 21.5 percent average of the four stocks and slightly below the index, with a beta of 0.33. Diversification therefore worked as theory predicts, even across only four names. The worst single months tell the same story: Campbell's fell 17.4 percent in one month and Prudential 17.3 percent, while Johnson & Johnson's worst month was a loss of 8.6 percent, smaller than the index's worst of 9.3 percent. For retired clients who may need to sell during a bad month, the depth of losses matters as much as their average size.

The equal-weighted portfolio's average return, however, was only 8.5 percent, held down by Campbell's. A portfolio of 40 percent each in Johnson & Johnson and Merck and 20 percent in Prudential, with no Campbell's, returned 15.3 percent with a standard deviation of 16.8 percent, a Sharpe ratio of 0.69. A search over weights in 5 percent steps found the lowest-risk mix at 40 percent Johnson & Johnson, 5 percent Merck, 35 percent Campbell's and 20 percent Prudential, with a standard deviation of 14.2 percent, but its average return was only 5.4 percent. Minimum variance is not the clients' goal; the trade-off between risk and return is.

Looking Forward: Required Returns

Past returns are a weak guide to future ones, so I also estimated required returns with the capital asset pricing model (Sharpe, 1964), using the 5.29 percent yield on 10-year Treasury notes at the end of September 2026, an equity premium of 5.5 percentage points and betas adjusted toward 1 to reduce estimation error. The adjusted betas are about 0.48 for Johnson & Johnson, 0.47 for Merck, 0.37 for Campbell's and 0.90 for Prudential, giving required returns of roughly 7.9, 7.9, 7.3 and 10.2 percent. These rates will serve as discount rates in the final valuations.

Preliminary View and Next Steps

On the evidence so far, the sleeve should be built mainly from Johnson & Johnson and Merck, with a smaller position in Prudential for its different business, and with Campbell's limited or excluded despite its 7.9 percent dividend yield. Two questions remain for the final paper. First, Campbell's debt and its dividend payout above earnings raise questions about financial distress that past returns do not capture. Second, the capital structures of all four companies, and how their dividend policies serve shareholders, may change the ranking. I will complete that analysis using each company's latest Form 10-K and deliver the recommendation with position sizes and income estimates.

References

Berk, J., & DeMarzo, P. (2020). Corporate finance: The core (5th ed.). Pearson.

Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. The Journal of Finance, 47(2), 427-465. https://doi.org/10.1111/j.1540-6261.1992.tb04398.x

Markowitz, H. (1952). Portfolio selection. The Journal of Finance, 7(1), 77-91. https://doi.org/10.1111/j.1540-6261.1952.tb01525.x

Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of Finance, 19(3), 425-442. https://doi.org/10.1111/j.1540-6261.1964.tb02865.x