Financial Economics Final Project

TEAM PROJECT EC545: Financial Economics

Boston University

Group Members:

Xiaolei Cao

Congyi Liu

Chayapol Phanhakarn

Weiming Huang

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Contents

1. Overview of the Current Economy 2016 ................................................................................ 2 1.1 Gross Domestic Product and Growth ............................................................................................. 2 1.2 Unemployment and Inflation Rate .................................................................................................. 3

1.2.1 Unemployment Rate .................................................................................................................... 3 1.1.2 Inflation Rate ............................................................................................................................... 4

1.3 Federal Budget .................................................................................................................................. 4 1.4 Trade Balance ................................................................................................................................... 6 1.5 Financial Markets ............................................................................................................................. 6

2. U.S. GDP Growth in the Near Future ..................................................................................... 8 2.1 Literature review (Campbell Harvey) ............................................................................................ 8 2.2 Historical performance .................................................................................................................... 8 2.3 Forecasting U.S. GDP growth in the next 6 quarters. ................................................................. 11

3. Sector Overview ...................................................................................................................... 12 3.1 Energy Sector .................................................................................................................................. 12 3.2 Health Care Sector: ........................................................................................................................ 14

4. Sector ETF ............................................................................................................................... 15

5. Stocks of Choice ...................................................................................................................... 16 5.1 Firm Description ............................................................................................................................. 16

5.1.1Exxon Mobil Corp. ..................................................................................................................... 16 5.1.2 AETNA Incorporation. (AET) .................................................................................................. 17

5.2 Financial Performances.................................................................................................................. 17 5.2.1 Exxon ........................................................................................................................................ 17 5.2.2 AET ........................................................................................................................................... 19

5.3 Stock Analysis and Market ............................................................................................................ 21 5.4 Comments and Remarks ................................................................................................................ 21

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15000

16000

17000

18000

19000

2014/Q4 2015/Q1 2015/Q2 2015/Q3 2015/Q4

Bill

ion

Do

llar

GDP Dollar Value

GDP

Real GDP

Portfolio Report 1. Overview of the Current Economy 2016

1.1 Gross Domestic Product and Growth

The presented GDP in the fourth quarter 2015 as of the announcement from Bureau of Economic

Analysis (BEA) on March,2016 increased at 2.3% and at 1.4% for real GDP. From quarter 2 in

2015, The real GDP rose sharply to 3.9% and after that it has kept increasing in the slower pace.

At the end of 2015, it started quiet slow at the first quarter but eventually it has increased from

17615.9 billion dollars to 18164.8 billion dollars. From the GDP perspective, it seems that the

U.S. has a well-being economic health and upward trend in the future.

Table 1. Gross Domestic Product (GDP) in Billion Dollars

Source: U.S Department of Commerce & Bureau of Economic Analysis

Figure 1. GDP Dollar Value in Recent Years


For the annual rate, BEA announced that in 2015 real GDP increased 2.4% which is the same

rate as in 2014. In 2015, diminishing in export and increasing in import were offset by the

acceleration in personal consumer expenditure and investment. However, BEA stated that federal

government spending decreased but too small to turn GDP downward. Those consumption and

investment sector are larger enough to compensate its plummeting.

Year/Quarter GDP Growth rate Real GDP Real Growth Rate

2014/Q4 17615.9 2.20% 16151.4 2.10%

2015/Q1 17649.3 0.80% 16177.3 0.60%

2015/Q2 17913.7 6.10% 16333.6 3.90%

2015/Q3 18060.2 3.30% 16414 2.00%

2015/Q4 18164.8 2.30% 16470.6 1.40%

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Figure 2. GDP Growth Rate in Recent Years


The net export of goods and service in the fourth quarter of 2015 decreased from the previous

quarter at the level of 530.4 billion dollars to 514.3 billion dollars. This declination resulted from

both import and export factor that decelerated. However, it was partly offset by the positive

contribution from Personal Consumer Expenditure, residential fixed investment, and federal

government spending. It resulted in increasing of GDP in the fourth quarter 2015.

1.2 Unemployment and Inflation Rate

1.2.1 Unemployment Rate

In March 2016, Bureau of Statistics (BLS) announced the unemployment rate as 5%. It was

approximately 8 million people who were considered as unemployed. It was better by comparing

it to March 2015 on a year-to-year basis, which was 5.5%. Since the world has encountered the

fluctuation of the oil price, the low oil price had a repercussion on mining sector. Obviously,

there was an increasing unemployment in some industries such as Mining and oil and gas

extraction, from 8% to 9.8%. Moreover, the increase in unemployment rate also showed in the

information and the financial activities as well.

Table 2. & Figure 3. Monthly Unemployment Rate from March 2015 to March 2016

Source: U.S Department of Labor & Bureau of Labor Statistics

0.00%

2.00%

4.00%

6.00%

8.00%

2014/Q4 2015/Q1 2015/Q2 2015/Q3 2015/Q4

Pe

rce

nt

GDP Growth Rate

GDP

Real GDP

4.6%

4.8%

5.0%

5.2%

5.4%

5.6%

Unemployment Rate

Unemployment Rate

Month/year

Unemployment

Rate

Mar-16 5%

Feb-16 4.90%

Jan-16 4.90%

Dec-15 5%

Nov-15 5%

Oct-15 5%

Sep-15 5.10%

Aug-15 5.10%

Jul-15 5.30%

Jun-15 5.30%

May-15 5.50%

Apr-15 5.40%

Mar-15 5.50%

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-0.50%

0.00%

0.50%

1.00%

1.50%

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5

De

c-1

5

Jan

-16

Feb

-16

Mar

-16

Inflation Rate

Inflation Rate

However, it was offset by an increasing employment in retail trade, construction, and

manufacturing industries. BLS also stated that there were a number of populations that was not

in labor force more than in March, 2015 around 0.6%. This should be counted as one of the

reasons of decreasing in unemployment rate. Overall, the job market improved compared to

March 2015.

1.1.2 Inflation Rate

US inflation rate has climbed in March 2016 since 2014. From the table below, the Consumer

Price Index for all items increased at 0.9% over the last months which is slightly smaller than the

index in February. An interesting finding in this month is that the gasoline (all types) ascended

after the dropped for consecutive 3 months, from 13% in February to 2.2% recently. The food

price decreased 0.2% after a rise in February. In 2015 inflation rate was around 0% until October

2015 that there was an incremental trend which reach the peak at 1.37% in January 2016. For the

first quarter of this year, there was a sign of decreasing in inflation rate even the energy price rise

but it was not enough to pull the CPI for all item to climb up.

Table 3. & Figure 4. Monthly Inflation Rate from March 2015 to March 2016


1.3 Federal Budget

According to the statistics from BEA, during the latest three years federal budgets of US

government are in deficits. For fiscal year 2017, the government plans to spend around 4.1

trillion dollars which is about 21.5% of gross domestic product (GDP). Even though the figure

shows that the deficit is somehow estimated to decrease in FY2017 compared to FY2016, it

doesn’t mean that the government will decrease its spending. According to the report of Office of

Management and Budget (OMD), the government outlay is estimated to increase from

approximately 3.9 trillion to 4.1 trillion dollars in FY2017, but its receipt is estimated to

increases for even more than the amount of outlays, thus results in a decreasing deficit.

The national debt balance as of March 31,2016 was composed of two sector. It was held by

public sector around 13.9 trillion dollars and 5.3 trillion dollars held by government. The table

shows that in FY2015, the federal deficit was about 438 billion dollars. In FY 2016, the federal

Month/Year Inflation Rate

Mar-16 0.9%

Feb-16 1.02%

Jan-16 1.37%

Dec-15 0.73%

Nov-15 0.50%

Oct-15 0.17%

Sep-15 -0.04%

Aug-15 0.20%

Jul-15 0.17%

Jun-15 0.12%

May-15 -0.04%

Apr-15 -0.20%

Mar-15 -0.07%

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government is estimated to have a 616 billion dollars deficit, the increment would be large

compared to the deficit in FY2014 and FY2015. The soar in the deficit estimated in 2016 results

from the tax-cut deal proposed by President Obama. The deficit in FY2015 counted to be 2.5%

of the total GDP and estimated to be 3.3% in 2016. The receipts of the federal government

mainly came from the individual income taxes, payroll taxes and corporate income taxes. And

the outlays were spending on social security, unemployment and labor, medicare and health,

national defense, and net income.

Table 4. The Federal Budget in Recent Fiscal Years

Source: Office of Management and Budget

Announced by BEA in March,2016, the deficit in the fourth quarter of 2015 decreased from

$129.9 billion to $125.3 billion from the previous quarter. And deficit also decreased from 2.9%

to 2.8% as percentage of GDP. As Figure 5 shows, in the fourth quarter of 2015, the surpluses

were on international trade in services, primary income. And the deficits were on international

trade in goods and secondary income.

Figure 5. U.S. Current-Account Balance and Its Components

Source: U.S. Bureau of Economic Analysis

Fiscal Year In Current Dollars (billion dollar) As Percentages of GDP

Receipts Outlays Surplus or

Deficit (–)

Receipts Outlays Surplus or

Deficit (–)

2014 3,021.5 3,506.1 -484.6 17.6 20.4 -2.8

2015 3,249.9 3,688.3 -438.4 18.3 20.7 -2.5

2016

estimate 3,335.5 3,951.3 -615.8 18.1 21.4 -3.3

2017

estimate 3,643.7 4,147.2 -503.5 18.9 21.5 -2.6

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1.4 Trade Balance

According to the U.S. Bureau of Economic Analysis (BEA), in 2015, the total deficit for goods

and service were $531.5 billion, increasing by $23.2 billion from 2014. Both the exports and

imports decreased compared to 2014. And the deficit in 2015 results from the increasing deficit

in goods and the decreasing surplus in services. The goods and services deficit counted for 3% of

the U.S. gross domestic product, decreased by 0.1% to 2014.

Announced in April, 2016, The goods and services deficits in February 2016 was 47.1 billion

dollars, increased from 45.9 billion dollars in January 2016. The export and import increased by

1.8 billion dollars and 3.0 billion dollars respectively. The increasing deficit in February also

derives from the increasing in goods deficit and decreasing in service surplus.

The U.S. Bureau of Economic Analysis stated further that the average goods and services deficits

increased 3.3 billion dollars compared to balance at February 2015. The average exports

decreased by $0.9 billion and the average imports increased by $0.2 billion.

1.5 Financial Markets

The prime interest rate was pegged at 3.25 from January 2009 to November 2015. After two

increases in December 2015 and January 2016, the prime rate is 3.5 currently. From 2008 till

now, the yield on long-term treasury securities performed a turbulent downward adjustment. The

fed discount rate was settled at 0.75 for a long period from the recession to the end of 2015, and

then was adjusted to 1. The federal funds rate was in a very low level during the past years, while

showed a little rise from the end of 2015.

Table 5. Comparison of Key Interest Rates in 2015 and 2016

April 2016 March 2016 April 2015

WSJ Prime Rate 3.50 3.50 3.25

Federal Discount Rate 1.00 1.00 0.75

Federal Fund Rate 0.37 0.37 0.13

Yield on Long-term Treasury

Securities (30 Yr)

2.61 2.75 2.58


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After the big recession in 2008, though experienced some fluctuations, the US stock market

started climbing up gradually these years. DJIA, S&P 500 index, and the NASDAQ index all

increased phenomenally.

Table 6. Stock Market Indices in 2015 and 2016

April 2016 March 2016 April 2015

Dow Jones Industrial

Average 17721.25 17229.13 18036.70

S&P 500 Index 2061.72 2019.64 2095.84

NASDAQ Index 4872.09 4750.28 4977.29


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2. U.S. GDP Growth in the Near Future

2.1 Literature review (Campbell Harvey)

Campbell Harvey proposed a method of using term structure of interest rates to forecasting

economic growth in the September 1989 Financial Analysts Journal article. The main idea of the

method is using interest rates as expected future payoffs, and expected future payoffs is a

reflection of general consensus of the economy.

Under the smoothing lifetime consumption preference, if the economy is expecting a slowdown

in the future then the demand of financial instruments will rise. Then the price of those financial

instruments will rise, therefore yield decline. In order to finance the purchase of those future

financial instruments, consumers may sell their shorter term assets. Shorter term asset price will

drop and therefore yield rise. Above all, if a recession is expected, we will be able to observe

long rates decrease and short rates increase. The spread (difference between long rates and short

rates) will narrow or even become negative. The shape of term structure or yield curve will

become flat or inverted in this scenario. Therefore, if we see an inverted term structure, we

would anticipate an economic downturn.

2.2 Historical performance

Campbell’s method has been successful in showing historical economy performance, and had

successfully predicted previous recessions. By adding recent data, we can recreate the analysis of

Campbell Harvey’s method.

In recreating the analysis, we chose the quarterly 1-year Treasury rate as short-term rate and 10-

year Treasury rate as long-term rate (average as aggregate method). We collected the interest rate

data from 1962 1st Quarter to 2015 4th Quarter. We also include real GDP and generate real

GDP growth rate during the same time span. Putting the real GDP growth and yield spreads

together we got the Figure 6.

Figure 6. U.S. Annual Real GDP Growth and Yield Spreads (1962-2015)

Source: Federal Reserve Bank of St. Louis

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From the Figure 6, we can see that yield spread indeed can predict business cycle. In particular,

yield spread will decrease before a recession occurs, and yield spread will increase before an

economic boom occurs. If the yield spread reach to negative, then it is very likely that the

economy is going to have a recession.

In order to verify the accuracy of Campbell Harvey's observations further, we separate the figure

into the 1970s, 1980s, 1990s and 2000s.

Figure 7. U.S. Annual Real GDP Growth and Yield Spreads 1970s


The 1970s has one recession which started around 1974, and the term structure started to become

inverted around early 1973, which was before the decline of GDP. The term structure went back

to normal before 1975, successfully predicted the economic recovery after 1975. In the end of

70s, we saw a clear inverted term structure beginning in the middle of 1978, which successfully

predicted the recessions in the 1980s (Figure 8).



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We saw the sharp decline of GDP in the beginning of 1980s. Then followed by an increase in

GDP and another decline in GDP. But term structure changes were able to predict those output

change 1-2 quarters ahead. Starting from later 1981 term structure went back to normal and

followed by a decade-long normal GDP growth. However, term structure became inverted in the

end of 80s. Which also successfully predicted the economic decline in 1990.



Except the first year in 1990s, which were predicted by the inverted term structure in the late

1980s, most of the 1990s were marked by positive GDP growth. And term structure was normal

throughout the whole decade.



After 2000s, there were two recessions, one in 2001-2002, which was predicted by the inverted

term structure in 2000, followed by a normal term structure predicting a normal growth. The

second recession, started in 2008, while we saw a negative spread in 2006, two years before the

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crisis, and this inverted term structure lasted for more than a year. Which predicted the financial

crisis in 2008. In 2007 the term structure went back to normal (even before the crisis), and not till

two years later in 2009, we saw a positive growth in GDP.

2.3 Forecasting U.S. GDP growth in the next 6 quarters.

Before the recession of 2008, the yield spread reached to negative, and the recession follows.

However, after 2008, the yield spread goes back to historical normal. When we look at the most

recent 6 quarters data (the most recent GDP growth data can be traced back to 2015 Q4, Graph

X), we saw that the spread between 1-year treasury and 10-year treasury is above zero. Although

there seems to have a declining trend of this spread, compared with the yield and spread graph

above (2000s), there is no clear sign for decline or narrowing of yield spread. Therefore, we

anticipate that the US Real GDP growth will stay around 0-1% in future.

Figure 11. U.S. Annual Real GDP Growth and Yield Spreads in Recent 6 Quarters


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3. Sector Overview

3.1 Energy Sector

Since 2014, the energy sector has witnessed a historical decline of oil price. This has largely due

to the oversupply of oil from several competing parts in the global market. Though we saw a

small increase in price recently, oil prices hit a 12-year low early in 2016 and even traded below

$30 per barrel at one point last year. As a result, the energy sector’s valuations have fallen to

historic lows. For example, the price-to-book ratio (Figure 12) shows that this measure has hit

the historical low point. However, this has been a good time to consider energy stocks because

they may generally rebound and delivered positive performance.

Figure 12. The Price-to-Book Ratio of Energy Sector

Looking forward, we anticipate an increase in US demand for oil due to the auto sales increase in

US as well as a better recovery of economy in General. In December 2015, the Fed has increased

its federal funds rate to 0.5% for the first time in 7 years. With the economy back on trail, we

anticipate there will be a rise in energy prices. The FOMC press release predicts that the energy

prices were expected to rise in latter 2016 (FOMC March: energy prices and the prices of non-

energy imported goods were expected to begin steadily rising later this year).

Besides evidence from Fed, we also looked into ETF, and specifically we looked at XLE, the

reason why we chose XLE will be illustrated in the next section. When we compare the XLE

performance and S&P 500 From Graph X, we saw that before the oil price drop in 2014, XLE

has a very close trend with S&P 500. While, after the oversupply of oil, we witness a sharp drop

in the return of XLE. The spread between market and XLE increase further with time pass by.

However, if we take a look at the recent performance of XLE (starting from 2016) we saw that

XLE starts to outperform the market after March, and we believe this trend will sustain in future.

This observation is also consistent with the overall booming of economy, increased sales of

automobile, and a slight increase in oil price recently.

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Figure 13. The XLE of Energy Sector in 2016

Figure 14. The XLE of Energy Sector in Years

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From January to March in 2016, the price of the XLE is fluctuating, while representing an

increasing trend. After March, the increasing trend is more apparent, indicating the rebound and

better performance in the future. Though the XLE is still low compared with the historical data

in 2014, it is a good time to invest in the energy sector now, with expected rebound and the

positive performance. The potential positive performance of XLE also be showed from the

increasing oil price. The oil market is rebalancing in 2016, which leads to the increasing of the

oil price. And there is a high probability that the price of oil will keep climbing rather than

falling down.

3.2 Health Care Sector

The health care sector has two main categories of companies: 1) the companies that specialized

in the production of health care equipment and the related services, including delivery and

distribution of equipment, maintenance of the facilities and operation of related organizations.

2) those specialize in R&D of the latest pharmaceuticals and biotechnology technology, and

related productions and marketing process.

The healthcare sector is still attractive for investors in 2016 and expected to have a long-term

growth trend, due to the fact of continuous growing of aging population, the increasing focus and

investment from the middle class in developing countries, the insensitivity to the business cycle

fluctuation, and the upcoming technology boom in this sector. The theme in 2016 is similar with

that in 2015, focusing on biotechnology, medical devices and healthcare information technology

(HCIT). In 2016, though there are risks from the possible changes in drug pricing due to the

election of the President, the main structure of the healthcare industry is not likely to change too

much.

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4. Sector ETF Among multiple ETFs, we chose XLE as our object of analysis. Rated as A+ in Liquidity, XLE

is an ETF that offers supremely liquid exposure to the U.S. energy giants in the S&P 500

referring to oil and gas industries. Though XLE’s portfolio is from S&P 500 rather than the

whole energy industry, it could still represent the overall market well, due to the

representativeness and directiveness of those big companies. Firms related in the energy value

chain, including production, exploration, refining and marketing the oil and gas energy and

equipment, comprise more than 80% of the assets of XLE. Compared to other ETFs in energy

industry, XLE is attractive for its cost efficiency and supreme liquidity.

As listed in Figure 15, the top 10 holdings of XLE are Exxon Mobil, Chevron, Schlumberger NV,

Valero Energy, EOG Resources, Occidental Petroleum, ConocoPhillips, Pioneer Natural

Resources, Tesoro and Phillips 66. Among these 10 corporations, Exxon and Chevron holds

most shares of XLE, accounted as 18.28% and 14.34% respectively. Then is Schlumberger NV,

accounted as 7.65%. The rest of the top 10 holding corporations are weighed between 3% and 4%

in the index.

XLE also has a diversifying sector breakdown as Figure 16 shows. It mainly invests in oil & gas

refining and marketing area, exploration and production area and services and equipment area,

and the weights of those three areas in the XLE are higher than the segment benchmark. XLE

also invests smaller fractions in energy transportation services, drilling, natural gas utilities and

coal.

Figure 15. The Top 10 Holding of XLE in Energy Sector

Figure 16. XLE Sector/Industry Breakdown

.

Source: ETF.COM

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5. Stocks of Choice

5.1 Firm Description

5.1.1Exxon Mobil Corp. (XOM)

Exxon Mobil Corp. (ExxonMobil) is an American multinational oil and gas corporation

headquartered in Irving, Texas. It is the largest direct descendant of John D. Rockefeller's

Standard Oil Company, and was formed on November 30, 1999 by the merger of Exxon

(formerly Standard Oil Company of New Jersey) and Mobil (formerly the Standard Oil

Company of New York). Over the last 125 years ExxonMobil has evolved from a regional

marketer of kerosene in the U.S. to the largest publicly traded petroleum and petrochemical

enterprise in the world. They make the products that drive modern transportation, power cities,

lubricate industry and provide petrochemical building blocks that lead to thousands of consumer

goods. There are thirteen board of directors and the average period of director is over five years.

They are professors of top-rated colleges or have leadership experience of large-scale

corporations. The board of directors are Michael J. Boskin (1996), Rex W. Tillerson (2004),

Samuel J. Palmisano (2006), Steven S Reinemund (2007), Larry R. Faulkner (2008), Kenneth C.

Frazier (2009), Peter Brabeck-Letmathe (2010), Ursula M. Burns (2012), Henrietta H. Fore

(2012), William C. Weldon (2013), Jay S. Fishman (2013), Douglas R. Oberhelman (2015) and

Darren W. Woods (2016).

Exxon Mobil’s main competitors are PetroChina, Chevron Corporation, British Petroleum, and

Valero Energy, which are all great oil and gas companies. During the past years, the competition

within the industry became more and more rigorous. Though US still hold the first role in the

market, China’s state firm had a strong growth these years. And there is no apparent

monopolistic power.

Figure 17. Top 10 Oil and Gas Companies by Market Value in 2015

https://en.wikipedia.org/wiki/Multinational_corporation

https://en.wikipedia.org/wiki/List_of_oil_exploration_and_production_companies

https://en.wikipedia.org/wiki/Irving,_Texas

https://en.wikipedia.org/wiki/Texas

https://en.wikipedia.org/wiki/John_D._Rockefeller

https://en.wikipedia.org/wiki/Standard_Oil_Company

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5.1.2 AETNA Incorporation. (AET)

AETNA Incorporation was founded in 1853 and its corporate headquarter is located at Hartford,

Connecticut. The present chairman and Chief Executive Officer is Mr. Mark T.Bertolini. He had

a role as CEO on 2010 and took as chairman on 2011. The president of the company is Karen S.

Lynch. She had a role as president on January 2015 and is considered as a first woman serving

this role in the company history. Furthermore, there are 10 executive vice presidents in the board

whose names are William J. Casazza (1992), Richard di Benedetto (2013), Shawn M. Guertin

(2011), Rick M. Jelonek, Steven B. Kelman, Gary Loveman (2015), Meg McCarthy (2003),

Harold L. Paz (2014), Fran S. Soistman (2008), Thomas W. Weidenkopf (2015).

AETNA Incorporation operates as a health care benefit company in the United States. The

company has three segments that they operate through, they are Health Care, Group Insurance,

and Large Case Pension. The company offer the broad range of consumer-directed health

insurance products and related services such as pharmacy, medical behavioral health, disability

plans and also medical management capabilities, Medical health care management, health

information technology products and services. Its customer target are employer groups,

individuals, college students, part-time and hourly workers, health plans, health care providers,

governmental units, government-sponsored plans, labor groups, and expatriates.

The main competitor of AETNA is UnitedHealth Group Incorperated (UNH) who has the

highest market capitalization which is 126.4 billion dollars while AETNA owns only 39.5 billion

dollars. However, AETNA is ranked the forth company by the industry market capitalization.

Another competitor that we should look at is Anthem Incorporation (ANTM) because of its

market capitalization is approximately as large as AETNA. AETNA has P/E ratio more than

ANTM and has more earning per share than UNH. Compared to the industry, AETNA’s earning

per share is far away higher from industry EPS-11.92 for industry and 6.78 for AETNA.

The nature of competition that exists in this industry may be considered as competitive market

rather than monopoly or oligopoly market. Seeing that the market capitalization of the industry is

2392 billion dollars while the highest market cap company owns only 126.4 billion dollars, there

are no firms that have power in order to manipulate the market.

5.2 Financial Performances

5.2.1 Exxon

a. Short Term Solvency Measures When we explore the short term solvency measures of Exxon, the current ratio, quick ratio and

cash ratio all showed descending trend in the past five years. The changes were quite turbulent

from 2011 to 2013, which was the period right before the surprising drop of oil price in 2014.

For such a leader in energy sector, Exxon’s performance can be seen as a signal of the industry.

But for the recent three years, the ratios were in a relative static state.

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Table 7. Current Ratio, Quick Ratio and Cash Ratio of Exxon

Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015

Lastest

Quarter

Current

Ratio 0.94 1.01 0.83 0.82 0.79 0.79

Quick

Ratio 0.66 0.69 0.53 0.5 0.44 0.44

Cash

Ratio 0.16 0.15 0.06 0.07 0.07 0.07

b. Long Term Solvency Measures (Leverage Ratios) The long term solvency measures here are debt to equity ratio and total debt ratio. They are

increased dramatically in five years. Though, the debt to equity ratio were kept in a pretty low

level, which presented a good status of financial status. We think one of the main reasons why

these ratios increased so much is that Exxon’s debt part became larger and larger during these

years. Exxon was contributed to expand several new programs and projects, especially in foreign

markets. For example, in 2011, ExxonMobil started a strategic cooperation with Russian oil

company Rosneft to develop the East-Prinovozemelsky field in the Kara Sea and the Tuapse

field in the Black Sea. And they started a coalbed methane development in Australia in 2012.

Table 8. The Debt, Equity and Total Debt Ratio of Exxon


Lastest

Quarter

Debt/Equity 0.06 0.05 0.04 0.07 0.12 0.12

Total Debt

Ratio 4.78 3.47 6.34 8.19 11.12 11.12

c. Asset Management or Turnover Ratios For measuring the efficiency of using the assets, we used inventory turnover ratio and asset

turnover ratio. Both ratio fell around 50 percent in five years due to the cool down of oil price.

Thus, the cost of goods sold and value of sales all decreased.

Table 9. The Inventory Turnover and Asset Turnover of EXXON

Dec 2011 Dec 2012 Dec 2013 Dec 2014 Dec 2015 TTM

Inventory

Turnover 24.31 22.73 20.55 18.05 11.44 11.44

Asset

Turnover 1.54 1.45 1.29 1.18 0.78 0.78

d. Profitability Measures The gloomy condition for the whole industry was also an influential impact on the falling profit

of Exxon. Net margin, return on asset, and return on equity all descended from 2011 to 2015. But

we cannot ignore the absolute value of these ratios were maintained in a good range.

https://en.wikipedia.org/wiki/Rosneft

https://en.wikipedia.org/wiki/East-Prinovozemelsky_field

https://en.wikipedia.org/wiki/Kara_Sea

https://en.wikipedia.org/wiki/Tuapse_field

https://en.wikipedia.org/wiki/Tuapse_field

https://en.wikipedia.org/wiki/Black_Sea

https://en.wikipedia.org/wiki/Coalbed_methane

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Table 10. The Return on Assets and Equity of EXXON


Net

Margin % 8.44 9.31 7.43 7.89 6.01 6.01

Return on

Assets % 12.96 13.5 9.57 9.34 4.71 4.71

Return on

Equity % 27.26 28.03 19.17 18.67 9.36 9.36

e. Market Value Measures From the perspective of investors, we measured earnings per share and price to earnings ratio in

the past five years. Obviously, earnings per share dropped significantly in 2015 as the weak oil

price. The lower EPS and increasing price per share were the important explanations of the jump

of PE ratio in 2015.

Table 11. Earnings Per Share and Price to Earnings Ratio of EXXON


Earnings

Per Share 8.42 9.7 7.37 7.6 3.85 3.85

Price to

Earnings

Ratio

10.03 8.94 12.71 11.56 20.96 20.96

5.2.2 AET

Looking at the solvency measurement in short–term and long-term, it may look worried because

of the Debt/Equity ratio is greater than 1. The main part of this liability is counted on future

policy benefit which depends on forecasting of mortality of insurer. Therefore, it doesn’t directly

reflect on the true cost of AETNA. Since the mortality prediction is increased, it resulting in

incremental of its liability. However, considered other measurements, those give ratio that less

than 1 which means AETNA still has the potential to pay its debt both in short-term and long-

term.

a. Short Term Solvency Measures

Table 12. Current Ratio, Quick Ratio and Cash Ratio of AET


Lastest

Quarter

Current

Ratio 0.69 0.98 0.77 0.77 0.82 0.82

Cash

Ratio 0.08 0.31 0.11 0.09 0.16 -

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b. Long Term Solvency Measures (Leverage Ratios)

Table 13. The Debt, Equity and Total Debt Ratio of AET


Lastest

Quarter

Debt/Equity 2.81 2.97 2.54 3.83 2.3 -

Total Debt

Ratio 0.73 0.75 0.72 0.73 0.69 -

c. Asset Management Turnover Ratios For the past five year, AETNA’s sale has grown up every year. The slightly increased and

consistency of the asset management turnover ratio showed that AETNA has a well management

in order to control the increasing sale volume.

Table 14. The Inventory Turnover and Asset Turnover of AET


Asset

Turnover 0.88 0.88 0.95 1.09 1.13 -

d. Profitability Measures

The profitability measurement is considered steady for the past five years. Even though the net

profit margin is slightly decreased, ROE rose sharply on 2014 and has a trend to go up from

2015 despite of the plummeting after its peak on 2014.

Table 15. The Return on Assets and Equity of AET


Net

Margin % 5.87 4.53 4.05 3.59 3.98 -

Return on

Assets % 5.15 4 3.84 3.85 4.48 5.57

Return on

Equity % 19.62 15.9 13.59 20.17 14.8 15.59

e. Market Value Measures

This should be attractive since its EPS and P/E ratio has increased in past five year. Its trend is

heading up. To compare recent P/E ratio to 2011, it is more than double up from 7.48 to 16.94.

This measurement can tell you about the return from the capital gain which is gain from

increased price. Moreover, from the historical dividend payout ratio, AETNA has generally pay

every quarters without any action to stop paying dividend. This shows that the company has a

good economic health and potential to keep paying dividend. Those dividend yield and capital

gain yield will lead to higher rate of return of AETNA stock.

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Table 16. Earnings Per Share and Price to Earnings Ratio of AET


Earnings

Per Share 5.33 4.87 5.38 5.74 6.86 6.78

Price to

Earnings

Ratio

7.48 9.13 12.42 14.98 15.73 16.94

5.3 Stock Analysis and Market

Indicator XOM AET S&P500 (Market)

Average Return* 0.0085 0.0250 0.0093

Average Risk Premium 0.0063 0.0229 0.0073

5-year Holding Period

Return**

0.6198 3.3188 0.78

5-year Holding Period

Risk Premium

0.4199 2.7913 0.55

Riskiness (Variance) 0.0029 0.0035 0.0012

Standard Deviation 0.0442 0.0596 0.0343

Correlation with Market 0.6862 0.4212

Correlation(XOM,AET) 0.2654

*the average return is computed based on monthly return

** the risk free rate used here is monthly risk free rate

5.4 Comments and Remarks

Currently, the oil price presents a warming trend and the whole energy market has experienced a

tough period turning back to the developing track. As a leader of energy market, we hold an

optimistic attitude towards Exxonmobil’s future. For the short-term, after two strong downward

pressures in September 2015 and January this year, XOM showed a steady growth in the last

three months in 2016. Although it is hard to buy a stock when it is at the bottom, without doubt,

investing at the beginning of its rising period will be profitable as well. For the long-term, we

can see Exxonmobil’s potential readily. The company commenced many foreign expansion

during the past years. They cooperated with various corporations in other countries, such as

Australia, China, Mexico, Russia, and Iraq. Another positive influence in the future that investors

should notice is environmental performance. Exxonmobil has various programs to contribute to

the environmental performance. Air emissions reductions, freshwater management, ecosystem

services, and spill prevention are kept improving with their efforts.

AET is a good choice to look at since the industry is healthcare industry, which has been doing

well for the past five years. We recommend this stock to invest for the following reasons: Firstly,

compared to the market (we use the S&P500 index as a proxy of the market) AET has been

doing better than the market during the past five years, and has an outstanding return to ratio rate

of 168.81%. Moreover, the five-year holding period returns which measures the amount of

money you got if you invest in AET 5 year ago, is 331.88% while the market has grown up only

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78% throughout the same period. These measurements of return show that the AET is able to

make a good profit for investors. Secondly, from the financial ratio, the earning per share and

price to earnings ratio has increased for the past five months. This shows a good sign of the

growth of AET. The profitability measure, net profit margin at 3.98% and Return on equity at

14.8, is considered better than the measure of this ratio of the industry-Net profit margin 3.2%

and return on equity 13.8% Thirdly, even though that the riskiness of AET is slightly more than

the market, the quotation of high risk high return should be recalled in your mind because of its

massive return that I have shown you from the table. But, I would like to remind you that it

depends on how risk-averse you are, or how much riskiness that you can tolerate.

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Financial Economics Final Project