A Model of Security Selection and Portfolio Building through Z-scores

Abstract

The main objective of this article is to study a stock selection model and at the same time to construct a model portfolio based on an investment strategy based on Altman Z-score. The Z-score model not only helps investors to build portfolio by selecting securities but also facilitates to find the probability of finding another firm in the same industry with a higher or lower financial parameter with respect to the industry average. For this study, five sectors were arbitrarily selected, namely, banking, cement, information technology, engineering and pharmaceutical. To achieve the study objectives, 25 companies belonging to the above-mentioned industries were selected on the basis of fundamental analysis especially based on five factors, namely, price to equity ratio, price to book value ratio, debt to equity ratio, dividend yield percentage and dividend payout ratio. The study shows how a portfolio can be constructed keeping a particular investment strategy in mind. Here, the article focuses on how long-term returns may be achieved relying on value investing strategy. This study helps to understand different portfolio models that can be created for different objectives and investment strategies. An attempt is made to further this by providing a comprehensive stock-selection exercise to understand how to appropriately pick stocks and create a portfolio. To conclude with, the present study provides investors a way to dive deeper into security analysis, selection process and building portfolio with the help of the Z-score model.