Investment Analysis of ABC Co. and XYZ Co.

My Uncle Zach has a lump sum amount with him which he is looking to invest, so we have come
across 2 companies ABC Co. and XYZ Co. We have returns available for the last 6 years(2013-
18) and based on these returns; we calculated the average returns & Standard deviation for each
of the stocks.
Year ABC Co XYZ Co
2013 37% 15%
2014 9% 13%
2015 -11% 14%
2016 8% -9%
2017 11% 12%
2018 4% 9%
Average Return: 9.7% 9.0%
Standard Deviation: 0.156 0.091
As we can see, The Average return of ABC Co is higher than that of XYZ co., but so is the
standard deviation. So if the investor is looking for a higher return, he will be needed to take
additional risk.
The correlation coefficient measures the strength of the relationship between two
variables( Ganti, 2019) On further calculation; we found out that the covariance between the two
stocks is 0.00184, and the correlation between the stocks is 0.13. which is pretty low, and due to
this, we can expect that a portfolio comprising both the stocks will have a higher return and a
lower SD. Based on the correlation coefficient of 0.13, we can say that ABC co & XYZ Co has

had a positive relationship with regards to movement on the stock price , i.e. if one stock
increases, the other stock also tends to increase. However the degree of movement is pretty low,
i.e. they don’t move at the same speed as each other.
The correlation coefficient is very important in case of personal Investments; It can be used to
manage risk better. Higher correlation simply means a higher risk to the combination of stocks.
The higher the correlation of the investments, the higher of the "doubling-down" effect (Russel,
2014). So a portfolio is better off with a low or negative correlation coefficient.
A combination of 50% in ABC and 50% in XYZ co gave us the following portfolio and its return
and standard deviation.
Year
Combined
Portfolio
2013 26.0%
2014 11.0%
2015 1.5%
2016 -0.5%
2017 11.5%
2018 6.5%
Average Return: 9.3%
Standard Deviation: 0.095
Portfolio Risk can be reduced by diversification, two or more stocks having a correlation of less
than 1 within themselves has the potential to generate a portfolio combining these stocks and