Question One
Alpha and Beta of a stock are important risk tools. Alpha refers to the measure of the investment compared to a given index. In effect, the tool measures the difference between the actual return and the expected returns. As such, it is a mathematical estimate of the investment return. Therefore, a positive Alpha means that the investment has outperformed the predicted performance. The converse is true for a negative value. The value of Alpha is obtained from the vertical intercept of the regression line, the intercept on the Y axis (Jones, 2010). Examining own computation regarding Apple and General Electric, Apple records a slightly positive intercept while General Electric has a negative intercept. Therefore, it means that Apple outperformed the CAPM rate of return while General Electric underperformance the predicted rate of return. As such, Apple outperformed its benchmark by 0.0692428% while General Electric has underperformed its benchmark by -0.0104238%.
Beta refers to the gradient of the slope when the stock values are regressed with the market values. As such, Beta measures the volatility of the stock with respects to the market. In essence, the Beta value has the ability to measures extreme movements of the stock prices that may not be captured by the Alpha measurement. However, similar to the Alpha measure, the Beta is also based on some benchmark. Therefore, Beta will capture the tendency of the stock to response to swings in the market. From own computations, Apple has a Beta value of 0.894330316 (Reuters Beta = 0.976214) meaning that the stock is less volatile than the market. However, the stock volatility is in the same direction with the market. On the other hand, General Electric has a 1.133248088 (Reuters Beta1.22356) Beta value. The meaning is that General Electric is more volatile than the benchmark; the stock is about 13% more volatile than the market (Reilly & Brown, 2012). However, the volatility is in the same direction as the market.
Adjusted R Squared is another insightful tool to apply. The value measures the goodness of fit of the regression model. A higher value of adjusted R-squared implies a better regression line and vice versa. Examining the computed values, General Electric has an adjusted R-square value of 0.647590166 meaning that the stock value movement and stock movement have a 64.75% linear relationship, the market can explain 64.75% of changes in General Electric price movements. On the other hand, Apple has 0.287253741 as its adjusted R-squared. The predictive power of the regression is quite low for Apple since there is only 28.72% linear relationship between the market values movements and Apple stock price movements (Jones, 2010).
The market movements and stock movement are highly influenced by the investors feeling of the market. As such, the movements are dependent on the investor confidence that is based on various factors mainly competitiveness and attractiveness of a given industry and firm (Roy, 2009). Therefore, porters five forces approach is used to grasp a better understanding of the industry and the firm where each of the two operates. The factors influence various factors that affect the firm’s performance that influencing the relationship between the firm and the market.
The bargaining power of the suppliers is defined by the uniqueness of the supplier’s product. In Apple case, the company has managed to wade off the supplier’s power by designing its own chips which are a key component in manufacturing its products. In addition, the firm has compelled various manufacturers that make various parts used by Apple to only make the components such that they can only function in apple’s products (Hasan, 2013). The strategies have managed to keep the production costs in check thus leading to the ability to sustain profits. On the other hand, General Electric has managed to tame the suppliers’ power through Ecomagination’s green venture. Bothe firms are in industries that have a high supplier bargaining power but the two have devised ways to tame the supplier of the suppliers.
Both GE and Apple operate in industries where the bargaining power of the buyer is relatively high. However, Apple has managed to limit this power by keeping switching cost high through keeping critical features of its product the same and easily transferable among its devices but low compatibility with competitors’ products (Hasan, 2013). However, although GE has heavily invested in Ecomagination’s green venture, the main source of buyers’ power is the compatibility of GE products with competitors’ products thus lowering switching costs (Miller, 2013).
In both industries, there is a relatively low threat of new entrants. The phenomenon is because of the high capital and expertise required to penetrate these industries.
In both industries, the threat of substitutes is very rife. As such, each firm has adopted defensive tactics where apple has continuously invested in making unique and simple to use devises that have evolved to match the evolving needs of its customers. On the other hand, GE major competitors have similar programs such as Ecomagination’s green venture (Miller, 2013). In addition, both firms have also heavily invested in the promotion of their products through hefty marketing budgets.
Competitive rivalry is relatively low in the two industries. There are countable players in each of the industries. However, the few have a wide range of products that compete in all fronts. In effect, apple has avoided price based competition and opted to compete on superior products (Hasan, 2013). However, due to the limitation of products in the electrical industry and severe competition in other lines of business that form the conglomerate, GE is still highly exposed to price based competition due to high replicability of the products they produce (Miller, 2013).
Questions Two
In relation to Apple, the required rate of return is 0.049% while the mean rate of return is 0.116%. The firm outperformed its required rate of return. On the other hand, General Electric required a rate of return is 0.058% while the mean average rate of return is 0.049%. As such, it is clear that General Electric underperformed its predicted rate of return. A similar observation is made when the Alpha value is examined.
General Electric has not posted encouraging results over the last three years. First, the firm beta value has been increasing where the last four years Beta is standing at 1.14 while the past three years Beta stands at 1.13. The gradual increase in Beta has a negative effect on the firm Alpha. A high Beta leads to a lower Alpha. As such, the implication here is that a low Alpha shows the firm’s inability to outperform the market while the converse is true. The value of Beta is affected by a number of various factors including financial leverage, Business mix and investors’ confidence in the leadership and confidence of the management among others (Vollmer, 2015). Examining the historical data, the organization leverage has been on the decline. As such, as this leverage declines, it leads to increased beta. In addition, the firm business mix has highly contributed to the sensitivity of the firm stock to market swings. General Electric business mix has increased the volatility of the firm’s stock since the firm has engaged in businesses that are considered risky such as retail finance business. As such, this has led to increased required rate of return as a result of increased Beta primarily due to the adverse perception that investors have had in relation to the firm’s management ability to steer the firm considering the extensive business lines which at times are outside the traditional business of the firm. In addition, the frequency at which the organization has been changing its business mix has a bearing on the perception the investors have on the organization management. These factors keep Beta high thus lowering the firm Alpha.
Apple has a high beta. Unlike General Electric, the firm has a high Beta but outperforms the benchmark. However, a closer look at the value of Alpha shows that this value is very small. Similar to General Electric, Apple too records a decreasing financial leverage which is one of the drivers of a high Beta. However, Apple has managed to utilize its business mix to its advantage. Through various and highly linked business mix, the firm has managed to register consistent profits over the years. Consequently, this works to credit the management ability to steer the company in the right direction. Since the fluctuations in stock markets are driven by information including financial performance information and governance, Apple information has raised investor confidence in the firm’s management. Although the Beta is still volatile, it can be argued that, compared to General Electric, Apple investors are more confidence in the management of the firm thus they hold the stocks for longer hence the lower volatility.
Question Three
Examining the raw data, Apple seems to be a better investment alternative compared to General Electric. Comparing the mean return, Apple has a bigger mean return compared to General Electric. Also, Apple exceeds its required rate of return while the General Electric falls short of the expected rate of return. Therefore, this makes the Apple more attractive than General Electric. In addition, considering the volatility of the two stocks, Apple has a lower Beta than General Electric. Volatility measures the extent of risk of the stock (Jones, 2010). As such, a higher Beta means that investing in that stock will expose the investor to greater risks. As such, considering both Beta and rate of return, it shows General Electric has a higher risk despite its lower rate of return compared to Apple. Therefore, this makes the Apple stock more attractive since it is safer and yield better returns.
References
Business & Financial News, Breaking US & International News | Reuters.com. (n.d.). Retrieved February 22, 2016, from http://www.reuters.com/
Hasan, R. (2013). Apple Inc. - An Analysis: PESTEL analysis, Porter’s 5 Forces analysis, SWOT analysis, Comprehensive analysis of financial ratios, and Comprehensive analysis of share performance of Apple Inc. GRIN Verlag.
Jones, C. P. (2010). Investments: Analysis and management. Hoboken, NJ: John Wiley & Sons.
Miller, W. D. (2013). Value maps: Valuation tools that unlock business wealth. Hoboken, NJ: Wiley.
Reilly, F. K., & Brown, K. C. (2012). Investment analysis & portfolio management. Mason, OH: South-Western Cengage Learning.
Roy, D. (2009). Strategic foresight and Porter's five forces: Towards a synthesis. München: GRIN.
Vollmer, M. (2015). A beta-return efficient portfolio optimisation following the CAPM: An analysis of international markets and sectors. Wiesbaden: Springer Gabler.
