Adams’s research report (see the previous problem) continued as follows: “With a business expansion already under way, the expected profit surge should lead to a much higher price for Universal Auto stock. We strongly recommend purchase.”
a. Discuss the business-cycle approach to investment timing. (Your answer should describe actions to be taken on both stocks and bonds at different points over a typical business cycle.)
b. Assuming Adams’s assertion is correct (that a business expansion is already under way), evaluate the timeliness of his recommendation to purchase Universal Auto, a cyclical stock, based on the business-cycle approach to investment timing.
Universal Auto is a large multinational corporation headquartered in the United States.
For segment reporting purposes, the company is engaged in two businesses: production of motor vehicles and information processing services.
The motor vehicle business is by far the larger of Universal’s two segments. It consists mainly of domestic United States passenger car production, but it also includes small truck manufacturing operations in the United States and passenger car production in other countries. This segment of Universal has had weak operating results for the past several years, including a large loss in 2012. Although the company does not reveal the operating results of its domestic passenger car segments, that part of Universal’s business is generally believed to be primarily responsible for the weak performance of its motor vehicle segment.
Idata, the information processing services segment of Universal, was started by Universal about 15 years ago. This business has shown strong, steady growth that has been entirely internal: No acquisitions have been made.
An excerpt from a research report on Universal prepared by Paul Adams, a CFA candidate, states: “Based on our assumption that Universal will be able to increase prices significantly on U.S. passenger cars in 2013, we project a multibillion-dollar profit improvement . . .”
