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Unit 9: Fundamental Analysis 3: Company Analysis

Beta Management Company was founded in 1988. A wealthy couple had become fed up Notes
with their investment losses stemming from the October 1987 crash and had asked their
friend, Ms. Wolfe, to manage a portion of their money. While business was slow at first,
she gradually developed a client base through good performance and word of mouth. She
considered herself a market strategist, and Beta Management’s stated goals were to enhance
returns but reduce risks for clients via market timing. Given the small size of her accounts,
the easiest way for her to maintain and adjust equity market exposure was to “index”. She
would keep a majority of Beta’s funds in no-load, low-expense index funds (with the
remainder in money market instruments), adjusting the level of market exposure between
50% and 99% of Beta’s funds in an attempt to “time the market.” She had toyed with using
a few different index funds at first, but soon settled on exclusive use of Vanguard’s Index
500 Trust due to its extremely low expense ratio and its success at closely matching the
return on the S&P 500 Index.
While Beta’s performance had lagged market returns in 1989, Ms. Wolfe had been quite
successful in 1990. She had reduced Beta’s equity position to 50% in June, partially missing
a large two-month market decline (see Table 1). After nervously waiting out August and
September, she began moving money back into the index fund. The report in front of her
showed that as of January 4, 1991, Beta Management had 79.2% of its $25 million invested
in the Vanguard fund; Beta had also made money for its clients during a down market
year.
This success had brought in enough new money to double the size of Beta in under six
months, allowing Ms. Wolfe to finally make the move to work full-time managing money.
But she had lost some potential new clients who had thought it unusual that Beta
Management used only an index mutual fund and picked none of its own stocks. Ms.
Wolfe had felt this same resistance in conversations with a few of the potential institutional
clients she was courting. As a result, one of her New Year’s resolutions had been to begin
looking at some individual stocks for possible purchase for Beta’s equity portfolio. She
would focus on smaller stocks, since she didn’t want to compete with Beta’s equity portfolio.
She would focus on smaller stocks, since she didn’t want to compete with larger, analyst-
staffed funds on their own turf, and also because she already had exposure to the S&P 500
stocks through investment in the index fund. She also decided to increase the proportion
of Beta’s assets in equities, since she felt the market was still a good value and that 1991
would be a good year.
As a first step toward both of these goals, Ms. Wolfe was considering immediately increasing
her equity exposure to 80% with the purchase of one of two stocks recommended by her
newly hired analyst. Both were small NYSE-listed companies whose stock price had eroded
over the past two years (see Table 1) to levels that seemed unreasonably low.
California R.E.I.T. was a real estate investment trust that made equity and mortgage
investments in income-producing properties (retail building 57%; industrial 17%; offices
15%; apartments 11%) in Arizona (51%), California (30%), and Washington (19%). Its
investments and stock price had been badly damaged by the “World Series” earthquake of
1989 and the downturn in California real estate values (see Table 1). Ms. Wolfe viewed it
as a good value, but noticed that it was an extremely volatile stock. Its stock price closed
at $2 ¼ per share on January 4, 1991.
Brown Group, Inc was one of the largest manufacturers and retailers of branded footwear,
and had been undergoing a major restructuring program since 1989. Earnings dropped in
1989 but had stayed positive and steady; the stock price had dropped substantially in late
1989 and late 1990. Ms. Wolfe knew that some of Brown’s many brand names – including
Jordache, Naturalizer, and Buster Brown – would wear well during the current recession,
Contd...

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