A Decision Model for Stock Portfolio Development

Abstract: This paper presents an investment decision-making model which can be used as a tool in abetting an investor in selecting stocks for an individual portfolio. Given a specific investor, the two step model provides recommendations on the percentage of available cash assets allocated to individual stocks. Step 1 - Individual Stock Performance Analysis - The investment model analyzes nine key financial criteria: analyst predictions, beta coefficient, debt-to-equity ratio, earnings per share, inventory turnover, price-to-book ratio, price-to-earnings ratio, return on asset, and return on equity. Using current values, each criterion is normalized on a 0 to 10 scale using utility curves. The criteria are then weighted using a pair-wise comparison technique and summed creating a ranked list of stocks. Step 2 - Portfolio Selection and Asset Allocation - The second step in model is to distribute the cash assets among the individual stocks focusing on the highest ranked stocks from the performance analysis. This is done using several portfolio risk criteria that can be modulated to either increase or decrease risk in the overall portfolio. Five criteria are considered in the model - number of stocks in the portfolio, number of stocks held in one market sector, number of mid or small cap stocks held, and percent of assets allocated to an individual stock. A linear programming model is used to maximize the utility value of the portfolio while constraining it based upon the given criteria. The model is demonstrated using a case study of the group members. A selection of 40 stocks were input into the model along with the pair-wise comparisons of the individual group members. The resulting output provided recommendations for the strongest portfolio for each individual investor