#kwhs

From October to December, I have been participating in an online competition held by Warton Business School- KWHS Online Investment Competition. Being the leader of the team, I (and my teammates) developed a thorough investment strategy and asset portfolio in order to maximize the return in the long run. We achieved a satisfying return and ranking in the end. Our final score was ranked 4th in Region 1. Below is the 25-page final report that I completed for this competition.

Final Report of KWHS

Section1: Team investment strategy:

Cautious trading with “right” timing to buy in

  Our team believes that there will be a lot of ups and downs in the world-wide stock market throughout Q4 of the year. For the whole US stock market, it did undergo a lot of variations due to the trade war between the US and China, as well as political factors such as the mid-term election. The continuous rise in interest rates has also driven down the whole US market. We will choose companies cautiously with the right timing to buy in and then hold them firmly for the long term.

Asset allocation + Risk diversification

  We as a team strive to find some relatively stable individual stocks that could offer the highest rate of return as possible. We invest in 5 different sectors to diversify our risks in case any sector is not doing well. Under the risk factor, we, therefore, try our best to diversify our portfolio allocation by investing in different sectors, therefore gaining the possible best return.

Investment on the leading companies in each sector for long-term return

  Our investment strategy is focused on the leading enterprise or BIG names in each sector to gain a stable return in the long term.

Buying large-dividends companies for short-term cash generation

 In the meantime, we also look into several companies that offer GOOD dividends at the end of the year, to generate the short term cash for our client Sachin Rekhi, who has the plan to make a donation to ASPCA annually. Those are normally “blue chip companies” with impressive dividends at the end of the financial year.

In summary, our main focus is to build a portfolio with long-term wealth creation while generating short-term liquidity.

The leading ompanies that we choose may undergo fluctuation, but our team look at them from a long-term perspective and therefore would not buy low and sell high. Under our assumptions, when there are slumps in the whole industry or market, these companies would suffer the least.

   We hold a weekly meeting to monitor and discuss the performance in each sector, after which we modify and improve our tactic under each sector. In addition, we are also left about 5% of the total asset, which is about 2000 dollars as cash flow.

Sector analysis:

   The relative proportion of our team's sectors allocation is as followed:

Next, we're going to analyze each sector, industry and the stocks we selected, as shown in the above form.

Consumer discretionary sector

   Consumer discretionary sector involves goods and services that are non-essential by consumers but are desirable if consumers have enough income to purchase them. Amazon is under the industry of retail while McDonald's is considered in the industry of leisure.  

    One reason behind the selection of Amazon as a top stock holding is due to the following industry trends: Discretionary sector will focus more on Amazon as the whole discretionary sector becomes more volatile, slower and more dependent on Amazon, like Netflix, Tripadvisor and media companies move to the communications sector. Since Amazon is one of the largest e-commerce companies, it is really matched with the trend in the consumer discretionary sector as spending on traditional retail has been cautious and reluctant. Consumers are now turning to e-commerce as a source of purchase.

    We believe that Amazon’s strategy of gradually merging online and offline retail looks promising. Looking into the qualitative data such as P/E value and EPS, cash flow as well as the growth of profit, we believe the long-term return of Amazon would be very promising.

Porter's Five forces analysis of retail industry:

Amazon: retail industry

Bargaining power of supplier - Low to medium

Amazon set a supplier code of conduct which has to be followed by its suppliers, including a few key areas: Child labor, involuntary labor; safety and health; working hours; anti-discrimination; fair treatment, immigration compliance, freedom of association, as well as ethical behavior.

Bargaining power of buyers -Medium to high

Amazon has focused on Customer retention by ensuring customer satisfaction as well as product quality.

Consumers can easily switch to physical retail and other sources of online retailing without any costs

Very elastic demand of consumers

The buyers from AWS (Amazon Web Services) have less power due to switching costs when turning to its alternatives.

Threats of substitutes -High

Physical retail

Increasing entrants of online retailers

Online retailers that are specific to a sector (Noble books, Best Buy, IKEA, BHS…)

However, substitutes for AWS are minimal.

Threats of new entrants -medium

Although there are barriers to entry existed such as economies of scale and retaliation from Amazon, innovative features and services may serve as a threat to Amazon.

New-entering firms will have easy access to different distribution channels such as UPS

The increasing popularity of online shopping will attract more entrants due to the abnormal profits

SWOT Analysis:

Strength: Low-cost structure, the largest online retailer in the world allowing a huge number of sellers

Figure 1. Amazon growth rate compared to e-commerce sales growth in U.S. (Source: Amazon financial reports and Digital Commerce 360)

The figure shows that Amazon has grown faster than the entire US e-commerce market, which implies that the company has taken its competitors' market share. According to the founder and CEO, Jeff Bezos, the company follows a cost leader strategy that is illustrated in the diagram: A lower cost structure leads to lower prices, which increases the customer experience. Customers will occasionally return back to the company to purchase more products, which thereby create the ever-growing traffic. It, as a result, attracts more sellers from the market, all of which leads to the large growth undergone by Amazon.

Figure2: Source: Seeking Alpha

In the meantime, the customer service rating of the company has remained the highest in the industry (a score of 85 on ACSI), higher than eBay, the biggest competitor. This also means that the customers have great confidence and satisfaction, and we believe that this could also reflect on its stock's future performances.

Figure 3: ACSI of Amazon from 1995 to 2018

 Weaknesses:

Increasing debt-to-asset ratio: Amazon's debt-to-asset ratio has been increasing so rapidly through 2013 which has far exceeded its main competitor, Wal-Mart.

Low-profit margin.

Opportunities:

The e-commerce sales of Amazon worldwide has been estimated to reach 4.5 trillion dollars in 2021 by forecasting, maintaining its largest e-retailer in the world.

Figure 4 total e-commerce sales of Amazon

Threats:

Wal-Mart has made great effort to establish itself as a leading online retailer

Due to the trend that the market of e-retailer is continuously being replaced by physical retail, the Walmart has also established e-commerce websites in more than 11 countries and its e-commerce sales had increased by 29% in 2016. However, we believe that it is extremely difficult to reach the magnitude or status as Amazon due to insufficient start-up capital, and it's hard to reach the same service and quality provided by Amazon.

In conclusion, low price, a huge product diversification as well as leading branding are essential factors that demonstrated the first place of Amazon being the largest retailers in the world as it has an operation in more than 100 countries.

It must be pointed out also, the other key reason that we are convinced to set a large proportion of our capital into the company is the fact that Amazon has not only been a leading E-business company, it has also successfully developed itself into a technology leading company. Amazon is leading in the key technology, such as Big Data, Cloud Computation, and AI.  Kindle E-book, Echo/Alexa, AWS and the Amazon Go are examples of a very successful product or service in the market. As a matter of fact, the R&D spending in the year 2017 from Amazon was the biggest in the world, as high as the US $ 23 billion!

We also purchased McDonald's as part of our portfolio allocation due to the short-term return: the dividend that it generates (2.5% annually) will be able to fulfill the donation requirement for our clients.

Consumer staple sector: Nestle and Moutai

Our strategy of investing in the Nestle in consumer staples sector is that the performance of the sector is relatively stable even when there are slumps in the market- the performance of food industry is always better than other sectors. On October 11th, the American stock market experienced a large decrease in value. Almost all the industries experienced a huge decline in the value per share. However, when we looked at the market of the food industry, the share values of these monopolies have increased a lot and still show a trend of going up. Compared with Coca Cola and Hersey and other big companies in this sector, Nestle had just begun to increase in the share value, and as this is the largest food company with diverse products portfolio as well as stable internal business performance, it successfully spreads its risks to a range of sectors that offers it great stability in the long run. As a result, we all agreed on the potential increase in the share value in the future.

Also, another reason why we choose to invest in the consumer staples sector is that the companies in this sector are always invested or having business activities in emerging markets, which shows a continuous growing demand in recent years, especially in the staple sector.

As for Nestle, it involves in the markets in big emerging markets like China, India. Also, it has a big percentage of business in developed countries like America and Britain. With stable revenue gained in the developed countries and stable growth in the emerging markets, the multinational food companies like Nestle will have good performance relative to other kinds of business.

We also purchased Kweichow MOUTAI, as it is symbolized as the ‘ National Wine’ in China, we see it as a potentially strong stock due to the following reasons:

First of all, it is the #1 Chinese Baijiu Company with unique brand image, as it is served as the national wine in the important banquet for visiting foreign government leaders. In addition, it is a high-end product that is viewed as a luxury brand, especially for Chinese consumers. Thirdly, Moutai company possess unique brewing techniques that can't be replicated, which All of these factors allows the company to enjoy a very high selling price, gaining an impressive net profit more than 50% in 2017, according to its financial statement. Last year, the dividend payout from the company also reached as high as 51%. This impressive dividends rate also persuade our members to buy it as a major of our short-term return that could be used for client's needs. Finally, the company has a very light asset without any heavy debt. It also possesses a large cash flow. Therefore, we believe the stock will continue to be the market STAR in the long run as well as short term, especially for the increasing demand as it is close to the Chinese New Year.

So, finally, we were happy to see the 13% return in the final result.

Technology sector

We invested a combination of 16% into the technology sector, 12% into Twitter Inc and 4% into Alphabet Inc, both of which are leading technology companies with large growth.

Our group chose Twitter seeing its constantly growing estimated earnings from 2014 to 2018 and a final reach of 2865.10 thousand at the end of 2018. The sales growth of the entire company was 28.57% in the previous year and 6.69% in the previous quarter. It also even experienced a 500% EPS growth in the previous year and 33.33% in the previous quarter. According to the Zacks Consensus Estimate, Twitter was expected to witness an increase of 11.3% to 79 cents per share, which reflects a year-over-year growth of 79.6%. Besides, its fiscal earnings have increased by 19% to 25 cents per share in the fourth quarter of 2018. It shorter term, it also experienced a 7.96% growth in its price change in the last four weeks. This demonstrates a relatively steady growth of revenue as well as a similar a rapid increase, seeing that Twitter has an imperative growth driving by currently focusing on adding new features and security initiatives, which can boost user engagement level and eventually boost its revenues.

Figure 5 sales revenue (source: Nasdaq)

In addition, Twitter’s ad revenues, which consisted 85.7% of its total revenues, are expected to be improved due to its deals with Disney’s ESPN, NBC, Universal, Viacom, Activision Blizzard, etc. It also begins to provide broadcasts of live sports which suits more for consumer’s tastes. Moreover, its another revenue source is enhanced currently, which is that its sources for new outlets and regular users to distribute instant information becomes estimated as invaluable. This helped to see its revenue jump 25% to $108 million in its ad revenues. Therefore, we believe the performance of Twitter in Q4 will be promising.

However, it is necessary to mention that we’ve invested only a small portion into this sector as our teammates agree that technology sector has been overvalued, demonstrated by several slumps in this sector in October and November.

Utility sector: American Electric Inc.

Our team has purchased 65 shares from American Electric Inc. from the utility sector. Listed at New York Stock Exchange (NYSE), it is among the largest generator of electricity in America, providing electricity for more than five million customers in eleven states.

Our investment in the utilities sector and industry accounts for 5% of total purchase. The sector contains stocks for utilities such as water, electricity, natural gas, etc.

Those companies within the utility sector provide consumers with very basic needs such as power and gas, so the goods are necessities that consumers are not likely to exit the market of this sector. In other words, goods and services of public utility have inelastic demand. Consequently, under regular circumstances, the prices of stocks within the sector tend to be reliable and steady. In light of these advantages, it is wise to include a percentage of stocks from the utility sector as a defensive portion.

Health care sector

Health care is always the most significant part that everyone would care about so we can not ignore this sector. The reason why we chose JNJ as 12% of our proportion mainly because it is a worldwide famous brand in medical products and providing health care service.

Final Trading results

In general, our team earned a satisfying trading result of 5.82% return and gained class rank 4th out of 259 teams. Our portfolio has performed stronger than class average as well as S&P index, which justified our strong portfolio allocation.

Team decision-making process

   In order to gain a thorough and deep understanding of the sector to which we are dedicated, within the first 2 weeks we barely bought any stocks; instead we spent time researching in different sectors in order to find its prospect; the structure of the sector; government policies and legislation and competition pattern, monopoly, etc. We did research on the big, dominant companies in the sector as a means to achieve the long-term source of return. In the meantime, we also had research on good companies that would offer a good return in the short run.

    On choosing the individual stocks, we briefly looked at the data overview of each company such as debt/capital ratio, market cap, 52 weeks high-low prices and such. In addition, we did compare the P/E value relative to industry to see whether there is a potential for the company to be overvalued. The most importantly, we looked at the trend of EPS value, revenue and earnings; cash flows to see whether the company is making a profit by glimpsing into their financial statements. Finally, we looked at the periods of the stock graph and the general trend in 5 days, 1 month and 1 year.

   Apart from the qualitative data, we also take into account the recent news of the company: such as M&A, litigation, innovation, improving services that match the new demand of customers, investment. We believe an incidence of any listed above would affect the performance of the stock market, but it won’t have a large impact in the long run. Finally, we made a balanced investment in the companies of our choice to generate long-term and short-term profits.

   The financial statement is a great qualitative tool from our perspective, as we believe that stock is about the confidence by customers’ perceiving to the company in the future and profitability is one of the key factors. Looking at the trend of the revenue growth of a company is a direct method for us to analyze.

   We believe that Porter's five forces are a very compelling tool for us to use, as it offers a clear view of the industry that the company is in such as its competition intensity, upstream and downstream firms, bargaining powers of suppliers and buyers. We really have a better knowledge of the general framework of the company in a certain industry and therefore able to analyze the profitability it could possibly gain in the future according to these forces.

We believe seeing the trend of a company's stock value may not be good to foresee or make accurate predictions of the future, as past incidents of the sudden slumps of big tech companies has all taught our teammates a lesson about how stock market is unstable due to external factors such as political incidents or monetary policy. Thus, an increasing trend of the past does not mean that it will continue to grow in the future.

Overall, we didn’t rely heavily on a specific tool, instead, we synthetically give each tool a proportion and eventually we view them only as assistance or reference to help our decision-making.

Section 3: team dynamics

Each and every member of our team is in charge of a sector of our investment: trade, research as well as report. We face a challenge of sector allocation in the first place as we couldn't decide how much proportion to set for each sector respectively. In addition, since we have a member of 5 students in our team, it is difficult for us to keep track of each student's progress as well as attendance.

We overcame the problem by establishing an online group and have a weekly online meeting every week to ensure every member is able to express their ideas and opinions. We didn’t have a lot of disagreement since we are only focused on one sector. However, some students are prone to quantitative analysis whereas some students like to be qualitative on research. Therefore, cooperation has helped us a lot. we helped each other in the area of what we're good at. For example, the member in our group who is good at math will help other students in quantitative research, for example. The members who have difficulties in analyzing the financial statement and indicators may receive help from other members, vice versa. On writing the final report, other students also dedicated in improving the language or grammar of students who are less skilled at writing.

Our advisor has also helped us especially when encountering the situation when the stock plummets, he always offers the prior notice or news and encourage us. Also, he has taught us some strategies to allocate our capital and when to make the trade.

Section 4: Takeaway

It is very unusual for teenagers like us to have an actual operation in the US stock market and this platform is just amazing for us to have a chance to give it a try without worries about losing practical money. The competition is more difficult than what we think in the first place as we never thought about risk diversification, asset allocation or industry analysis before.

Through this competition, we as a team have come to realize the importance of long term strategy. Shortly after inception, when we had not done much research and developed a plan for investment, we chose our stocks simply by looking at the price charts of stocks in each sector. During the competition when we were considering writing mid-review, we recognize that investment is not only about “buying low and selling high”. We became interested in how miscellaneous factors such as consumers, government policies and features of sectors and companies influence the price of stocks. Though it is almost impossible to predict precisely the prospect of each enterprise. Learning not to be frustrated by the short-term fluctuation of prices, we put a lot of effort into framing a strategy for a steady return in the long run.

We held the weekly meeting and in the middle of the competition, we have met some difficulties as we believe that since the US stock market has been of high-valued (high stock price) throughout the years, due to rising interest, trade war or other political reasons, the variation and fluctuations are of high possibility. The stock of Apple, as well as some other tech stocks, have proven the point that there is going to be periods of dumping. We even sent email to ask if it's possible to short-selling. I think through this competition all of the members have gained a deep understanding of the stock market operation and the condition right now, but more importantly, we thought deeply and tried a best to find solutions.

Due to the short length of the competition, our members could only choose stocks that may generate a relatively short-term return as it has to have an impact in 3 months. But if we're truly viewing this from the long-term perspective, we would probably choose some other stocks like Apple Inc. Although it hasn’t been performing well in the stock market, mainly because of  being unable to generate innovative products in recent 2 years, we believe it has great potential for great growth in the long run, considering its unique Chip+OS+Terminal+ Service as well as its great branding worldwide, for example, when it introduces is in the market.