Advancement in Portfolio Construction: P/E Ratio

Advancement in portfolio construction
Portfolio construction is the process of understanding how different asset classes, funds and weight-
ings impact each other, their performance and risk and how decisions ladder up to an investor’s ob-
jectives. To plan for the portfolio investment, we must take an in-depth look at all current assets,
investments, and debts if any so we can define financial goals for the short and long terms. To es-
tablish a risk-return profile, we have to decide on the extent of risk and volatility we are willing to
take, and what returns we want to generate.
Portfolio identification
Investment opportunities are defined, portfolios are matched with investment priorities, and risk and
performance of portfolios are tracked. This helps investment managers to easily filter information,
take advantage of opportunities for statistical arbitration and address inefficiencies, such as transac-
tion costs incurred during trading operations and the tax implications of investment decisions.
P/E ratio
The price-to-earnings ratio (P/E ratio) is used to measure a company’s current share price rela-
tive to its per-share earnings (EPS). Often the price-to - earnings ratio is also known as the mul-
tiple price or the multiple earnings. P / E ratios are used to determine the relative value of a com-
pany 's stock in an apples-to-apples analysis by investors and analysts. It can even be used to
compare a company against its own past record or to compare aggregate markets against one an-
other over a period of time. A high P / E means that, relative to companies with a lower P / E,
investors expect faster earnings growth in the future. A low P / E can mean either that a business
might be undervalued at present or that the business is doing extremely well in comparison to its
past patterns.
F-score
What Is the Piotroski Score?
The Piotroski score is a distinct 0-9 score that represents nine parameters used to determine the
strength of the financial position of a company. To classify the best value stocks, the Piotroski
score is used, with nine being the best and zero being the worst. Based on particular aspects of
company financial statements, the Piotroski score was named after Chicago Accounting Profes-
sor Joseph Piotroski, who invented the scale. For every criterion that is met with, one point is
awarded. If not, no points are awarded. The points are then added up to finally get the best value
stocks. The Piotroski score is broken down into profitability; leverage, liquidity, and source of
funds; and operating efficiency categories, as follows:
Profitability Criteria
Positive Net Income (1 point)
Positive return on assets in the current year (1 point)
Positive operating cash flow in the current year (1 point)
Cash flow from operations being greater than net Income (quality of earnings) (1 point)
Leverage, Liquidity, and Source of Funds Criteria
Lower ratio of long term debt in the current period, compared to the previous year (decreased
leverage) (1 point)
Greater current ratio this year compared to the previous year (more liquidity) (1 point)
No new shares were issued in the last year (lack of dilution) (1 point).
Operating Efficiency Criteria
A greater gross margin compared to the previous year (1 point)
A greater asset turnover ratio compared to the previous year (1 point)
If a company has a score of 8 or 9, it is considered a good value. If the score totals to between 0-
2 points, the asset is considered weak.
ESG Investing
One of the recent development in the field of portfolio management, especially portfolio selection is
the emergence of ESG (Environmental, Social, Governance) investing.This is an umbrella term for
investments that seek positive returns and long-term impact on society, environment and the per-
formance of the business.
Portfolio selection
The problem of portfolio selection is the problem of scarce resources. It is not just which instru-
ments to own but how the distribution of the investor’s wealth among the assets (proportion) should
look like. In the world of asset management, portfolio selection is one of the biggest dilemmas be-
cause the future value of all the asset is unknown when the investment decision is made, therefore,
leading to uncertainties.
Many portfolio selection trends and models have emerged in order to provide some assistance in
making such a decision. Each model is a simplification of real world situations. Hence, they be-
come more complex. These involve factors such as liquidity, cardinality, constraints, transaction
costs, short sale, etc.
Modern Portfolio Theory:

MPT is a standard financial and academic method for ascertaining the performance of a stock or
a stock fund as compared to its benchmark index. Modern portfolio theory (MPT) is a theory on
how risk-averse investors can construct portfolios to maximize expected return based on a given
level of market risk. Harry Markowitz pioneered this theory in his paper "Portfolio Selection,"
which was published in the Journal of Finance in 1952.
Five key risk indicators are in place, and each measure offers a specific way of evaluating the
risk present in the investments under consideration. Alpha, beta, R-squared, standard deviation,
and Sharpe ratio are included in the five tests. Risk assessments may be used to conduct a risk
assessment independently or together. When comparing two possible investments, it is prudent to
compare how to assess the most risky investment.
Mean Variance Model:

Mean-variance analysis is one aspect of modern portfolio theory , which suggests that if they
have complete information, investors will make sound investment decisions. One theory is that
investors want low risk and high rewards. In mean-variance analysis , there are two key compo-
nents: variance and predicted return. Variance is a number reflecting how varied the numbers in a
set are or how spread out. For example, variance tells how spread out the returns of a specific
asset are on a daily or weekly basis. The anticipated return is a probability that expresses the pro-
jected return of the security investment. If two separate securities have the same anticipated re-
turn, but one has lower variance, the better pick is the one with lower variance. Likewise, if two
different securities have roughly the same volatility, the better pick is the one with the higher re-
turn.
Minimax Model:
This model is based on game theory. Minimax model properties are generated and the risk
threshold parametric analysis links this model to the expected value along a continuum, exposing
an effective frontier that divides investors by risk preference. For one of these prior distributions,
the minimax model can optimize return, offering useful insight into the risk attitude and deci-
sion-making actions of an investor.
Portfolio diversification
To secure their investments against risk, there are many things that investors do. Diversifying is one
effective way to secure one's portfolio. In short, this implies that an investor prefers to include dif-
ferent kinds of securities and investments from various issuers and industries.The idea here is the
same as the old adage “don’t put your eggs all in one basket.” Diversification is a great strategy for
anyone looking to reduce risk on their investment for the long term. The process of diversification
includes investing in more than one type of asset. This means including bonds, shares, commodi-
ties, REITs, hybrids, and more in your portfolio.
Diversification of Risk through Multi-Asset Class Investment

Investing in several different securities within each asset. A diversified portfolio spreads invest-
ments around in different securities of the same asset type meaning multiple bonds from
different issuers, shares in several companies from different industries, etc.
Post-covid diversification and Gold

Applying appropriate diversification could result in the reduction of all forms of financial risks.
A new type of asset that could replace a certain or a certain number of financial assets and that
would have divergent market fluctuations that would minimize losses and the degree of risk at
the level of the portfolio was important for the new structuring of the investment portfolio. The
commodities that are necessary for these operations are gold, also referred to as investing in a
safe haven. The effect of gold as a new commodity that can provide investors with the required
degree of diversification and hedging will be observed in some financial positions. The use of
gold as a safe asset is not recent, and in past financial crises, this precious metal has played a ma-
jor investment role. A substantial degree of price fluctuation of this precious metal has been con-
ditioned by the growth of aggregate demand for precious metals, specifically gold. Investing in
gold as a safe haven has shown an impact of eliminating market and currency risks both on the
monetary side to mitigate financial risks and on side currency exchange and market movements.
Of course, because of the unsustainable aggregate demand for these assets, their value continues
to increase throughout the crisis, and the optimum volume of these assets needs to be calculated
at the level of the portfolio, allowing for the highest rate of return on investment based on the
amount of risk (VaR).
Bitcoins and diversification
Investors, speculators, academics and regulators have given Bitcoin tremendous publicity. Much
literature has focused on key topics, such as whether Bitcoin is a currency or a speculative asset,
its dynamics of uncertainty, market inefficiency, other asset interactions, and derivative product
growth.
Bitcoin investing offers an important hedging tool for a wide variety of industrial sectors and
shares, with findings found to be stable through the use of a cryptocurrency index and portfolios
of the US industry. Given the rise of cryptocurrencies as a currency or speculative investment,
future research is justified on whether, in the sense of future cryptocurrencies regulation, it can
be used to encourage diversification practices with financial assets across borders, emerging and
advanced economies.
References:
Rula Hani, Md. Aminul Islam (2016), Portfolio selection problem: Models review, Link: https://
www.researchgate.net/publication/310597782_Portfolio_Selection_Problem_Models_Review?en-
richId=rgreq-c430ef0ea09eb83cd931a4522920760f
Vladimir Zivanovic (2020), Gold as Assets or Safe Haven and Portfolio Diversification , Research
gate:https://www.researchgate.net/publication/343798040_Gold_as_Assets_or_Safe_Haven_and_-
Portfolio_Diversification
Florin Turcas, Florin Dumiter, Petre Brezeanu, Pavel Farcas & Sorina Coroiu (2017) Practical as-
pects of portfolio selection and optimisation on the capital market, Economic Research-Ekonomska
Istraživanja, 30:1, 14-30, DOI: 10.1080/1331677X.2016.1265893
Md Akhtaruzzaman ,Shaen Corbet ,Ahmet Sensoy (2019), The influence of Bitcoin on Portfolio
Diversification and Design, Research gate: https://www.researchgate.net/publication/
336874328_The_influence_of_Bitcoin_on_Portfolio_Diversification_and_Design

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Advancement in portfolio construction

Modern Portfolio Theory:

Mean Variance Model:

Diversification of Risk through Multi-Asset Class Investment

Post-covid diversification and Gold

Bitcoins and diversification

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