UV0517

DARDEN CAPITAL MANAGEMENT

THE MONTICELLO FUND

In early April 2004, the Monticello Fund Management Team was in the midst of its first
meeting of the new fiscal year. The team was part of the Darden Capital Management program at
the Darden Graduate School of Business Administration, where MBA students were entrusted
with managing endowment capital for the school foundation. The program sought to prepare its
participants for careers in investment analysis and portfolio management, with the recognition
that hands-on investment-management experience was an important aspect of professional
training. The total assets under management for the Darden Capital Management program were
over $3 million and were held in three funds: the Darden Fund, Monticello Fund, and Jefferson
Fund. Each fund was managed independently by a small team of MBA students, with some
guidance from a faculty advisor and a board of trustees.

The investment strategy of the Monticello Fund was to use fundamental analysis to identify
and invest in companies that were well-positioned for growth but inexpensively valued. The fund
team looked for stocks that would generate above-normal returns over a one- to four-year horizon.
The new team replaced a team that had generated returns of 42.9% on their equity positions over
the 12 months ending March 31, 2004. Such return performance was impressive both in absolute
terms and with respect to the strong 35.1% returns over the same period on the S&P 500 market
index. Exhibit 1 shows the current composition of the fund portfolio. The new team was unified in
its resolve to once again beat the market index in the coming year; however, there was some debate
on the most appropriate strategy to accomplish this goal.

The Portfolio Allocation Decision

Prior to the meeting, Senior Manager Steve Majocha solicited from the team a list of
securities for consideration as investment candidates. This request generated a list of six stocks for
which there was mixed enthusiasm: Boise Cascade, Boston Beer, Micron Technologies, New York
Times, and Placer Dome. Exhibit 2 shows the monthly return performance of each of the six
stocks over the past five years. Exhibit 3 provides various return statistics and other risk measures.
For each stock, the team had developed a financial forecast and an estimate of the fair-value of the
stock in 2007. Based on these figures, the team had calculated the anticipated rate of return implied

This case was prepared by Professor Michael J. Schill. It has some fictionalized content and was written as a basis
for class discussion rather than to illustrate effective or ineffective handling of an administrative situation.
Copyright © 2004 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved.
To order copies, send an e-mail to sales@dardenpublishing.com. No part of this publication may be reproduced,
stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic,
mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.
 -2- UV0517

by the current stock price. Exhibit 4 contains the anticipated return estimates. Majocha’s
suggestion that the team narrow the list to two or three stocks had generated a heated discussion.

Nandini Bose and Brian Maguire were strong proponents of buying Micron Technologies
stock. The stock had declined dramatically from its 2000 peak, and they now felt it was well
positioned to rebound. The team agreed that Micron offered the greatest expected return potential.

David Khtikian, however, insisted that Micron’s strong potential required accepting
substantially greater risk. He backed up his claim by comparing the standard deviations of past
returns. For each stock, he calculated the ratio of anticipated return to the standard deviation of
returns, and found that Boise Cascade and New York Times maintained the best returns for the
commensurate level of risk.

Charles Hill agreed with Khtikian that the anticipated returns should be normalized by
the associated risk of the stock. He claimed, however, that a better measure of the risk faced by
the investor was the correlation of the returns of the firm’s stock with those of a diversified
portfolio. This correlation could be measured as the slope of a linear-regression line, commonly
called the “beta.” Hill suggested that Mylan Labs and Placer Dome maintained the highest beta-
adjusted returns (the anticipated return less than expected by the return model that incorporated
beta, the Capital Asset Pricing Model).

Khtikian disagreed strongly, claiming that it made no sense to invest in a high-risk

Canadian gold stock that was expected to generate a return of less than 9%. Hill countered that
the attractiveness of Placer Dome stock was primarily in its diversification effect. He claimed
that a 50–50 weighted portfolio with Mylan Labs and Placer Dome would prove to be better than
simply holding Mylan Labs stock alone.

Majocha was due at a fund managers meeting in the morning and needed to be able to
communicate a coherent portfolio strategy for the Monticello Fund. Majocha considered the
recommendations of his team members and contrasted their views with what he knew of capital
markets. (Exhibits 5 and 6 provide some data on current and historical capital market
conditions.)
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Exhibit 1
DARDEN CAPITAL MANAGEMENT
THE MONTICELLO FUND
Composition of the Monticello Fund (March 2004)

% of portfolio Net 12-month gain %

Stocks
Patina Oil & Gas 5.6% 101.5%
General Dynamics 4.5 64.4
Berkshire Hathaway B 4.5 45.6
Sanderson Farms 4.3 11.5
NBTY 4.3 105.3
Mentor 4.3 34.8
Chicago Bridge & Iron 4.2 23.8
Kellogg 4.1 10.6
Chevron Texaco 3.9 2.9
Pier 1 3.9 30.1
Target 3.9 54.9
Pepsico 3.9 36.2
Pfizer 3.6 14.5
Johnson & Johnson 3.6 -5.4
Media General 3.6 38.2
Radian 3.5 3.1
Washington Mutual 3.3 23.3
Microsoft 2.3 3.6
Skywest 2.1 4.0
Bonds 17.8% 3.9%
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Exhibit 2
DARDEN CAPITAL MANAGEMENT
THE MONTICELLO FUND
Monthly returns for proposed stocks (1999–2003)

Boise Boston Micron Mylan New York Placer

Cascade Beer Tech Labs Times Dome
Jan-99 -3% 13% 54% -3% -1% -3%
Feb-99 3% -21% -26% -10% -9% -2%
Mar-99 5% 2% -16% 1% -8% 3%
Apr-99 25% 10% -23% -17% 21% 26%
May-99 -2% -2% 2% 12% 0% -21%
Jun-99 9% -3% 7% 5% 8% 6%
Jul-99 -10% 15% 52% -14% 7% -13%
Aug-99 -6% -16% 21% -13% 0% 3%
Sep-99 1% 2% -11% -7% -4% 43%
Oct-99 -2% -2% 7% -2% 7% -17%
Nov-99 -3% -7% -6% 31% -4% -8%
Dec-99 18% 0% 16% 7% 28% -6%
Jan-00 -13% 3% -20% 6% -7% -17%
Feb-00 -16% -2% 54% -14% -7% -1%
Mar-00 17% 3% 31% 20% 2% -6%
Apr-00 -6% 5% 11% 3% -4% 1%
May-00 -11% 8% 0% -5% -6% 0%
Jun-00 -11% 1% 26% -32% 2% 17%
Jul-00 7% 2% -7% 17% 4% -11%
Aug-00 8% 6% 0% 25% -5% 5%
Sep-00 -11% -3% -44% 2% 0% 6%
Oct-00 8% -14% -24% 4% -7% -14%
Nov-00 1% 4% -9% -15% -4% 11%
Dec-00 17% 9% 13% 6% 13% 6%
Jan-01 -2% 2% 29% -7% 9% -8%
Feb-01 -3% 9% -25% 0% 2% 7%
Mar-01 -2% -3% 21% 11% -7% -8%
Apr-01 11% -4% 9% 4% 0% 17%
May-01 1% 8% -17% 19% 3% 5%
Jun-01 0% -13% 10% -11% 0% -8%
Jul-01 3% 23% 2% 20% 10% 3%
Aug-01 1% 9% -10% -2% -7% 10%
Sep-01 -19% 2% -50% -1% -9% 16%
Oct-01 -3% -1% 21% 13% 6% -11%
Nov-01 12% 18% 19% -7% 10% -4%
Dec-01 7% 24% 14% 9% -5% 0%
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Exhibit 2 (continued)

Monthly returns for proposed stocks (1999–2003)

Boise Boston Micron Mylan New York Placer

Cascade Beer Tech Labs Times Dome
Jan-02 5% -10% 9% -10% -3% 13%
Feb-02 1% -15% -5% -10% 4% -5%
Mar-02 1% 15% 2% -3% 9% 5%
Apr-02 -7% -4% -28% -10% -3% -4%
May-02 5% 14% -1% 17% 8% 16%
Jun-02 -3% -4% -14% 2% 2% -18%
Jul-02 -16% -12% -4% 4% -12% -25%
Aug-02 -7% 2% -11% 1% 5% 20%
Sep-02 -15% -3% -28% 1% -4% -8%
Oct-02 4% 13% 29% -4% 7% -5%
Nov-02 14% 0% -1% 7% 0% 11%
Dec-02 -6% -9% -38% 4% -5% 20%
Jan-03 -5% 3% -16% 15% 7% -2%
Feb-03 1% -11% -3% 7% -5% -13%
Mar-03 -9% -4% 2% 1% -7% 0%
Apr-03 5% 3% 4% -2% 7% 1%
May-03 7% 9% 33% 2% 4% 11%
Jun-03 -2% 2% 4% 21% -5% 12%
Jul-03 4% 5% 25% -3% -2% 0%
Aug-03 10% 4% -2% 8% 0% 11%
Sep-03 2% 1% -7% 6% -2% 1%
Oct-03 2% 7% 7% -6% 9% 12%
Nov-03 5% 8% -9% 5% -3% 18%
Dec-03 12% -1% 4% 0% 4% -1%

Annualized Mean 8.2% 20.2% 16.6% 20.7% 11.0% 19.0%

Annualized Std. Deviation 31.2% 31.7% 76.2% 39.4% 25.8% 43.2%
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Exhibit 3
DARDEN CAPITAL MANAGEMENT
THE MONTICELLO FUND
Characteristics and return statistics for proposed stocks

Monthly returns 1999–2003

Average Annualized Beta estimate1 Dividend Safety PE Bond
Company name Industry annual std. deviation Raw Value Line Yield rating2 Ratio3 rating
Boise Cascade Paper products 8.2% 31.2% 1.14 1.20 1.80% 3 27.0 Ba2

Boston Beer Alcoholic beverages 20.2% 31.7% 0.46 0.55 0.00% 3 22.9 NA

Micron Technologies Semiconductors 16.6% 76.2% 2.19 1.70 0.00% 5 NMF B2

Mylan Labs Pharmaceutical 20.7% 39.4% 0.26 0.70 0.51% 3 18.9 NA

New York Times Newspapers 11.0% 25.8% 0.72 0.90 1.30% 2 23.1 A1

Placer Dome Gold and silver 19.0% 43.2% 0.25 0.40 0.61% 3 28.3 Baa2

Source: Value Line (VL), Center for Research in Security Prices (CRSP), Mergent’s Bond Record.
1
The raw-returns beta is estimated as the slope coefficient of stock return regressed on S&P 500 return (60 months). An example of the
regression estimation is provided in Exhibit 7. The Value Line beta is an alternative estimate provided by the Value Line Investment Survey.
2
The Value Line safety rating measures the price stability and financial strength of a firm. Safety ranks range from 1 (highest) to 5 (lowest).
3
The PE ratio is defined here as the current price divided by earnings for the past 12 months.
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Exhibit 4
DARDEN CAPITAL MANAGEMENT
THE MONTICELLO FUND
Model for estimating anticipated return for proposed stocks

Company name Current price Dividends per share Dividend growth rate Anticipated 2007 Anticipated 2007 Anticipated annual
2004 Earnings per share PE return (2004–2007)

Boise Cascade $33.40 $0.60 0% $2.02 23.5 10.8%

Boston Beer 17.54 0.00 0% 1.00 24.0 8.2%

Micron 15.25 0.00 0% 0.30 83.0 13.0%

Technologies
Mylan Labs 23.55 0.12 5% 1.46 24.0 10.9%

New York Times 46.01 0.60 4% 3.76 16.5 9.0%

Placer Dome 16.43 0.10 15% 0.75 30.0 8.8%

Source: Case writer analysis.

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Exhibit 5
DARDEN CAPITAL MANAGEMENT
THE MONTICELLO FUND
Summary statistics of annual returns for various classes of securities
(Annual returns over period 1926 to 2003)

Series Geometric mean1 Arithmetic mean2 Std. deviation

Inflation 3.0% 3.1% 4.3%

(Consumer price index)

U.S. Treasury Bills 3.7 3.8 3.1

(30-day)

Intermediate-term Government 5.4 5.5 5.7

(5-year)

Long-term Government 5.4 5.8 9.4

(20-year)

Long-term Corporate Bonds 5.9 6.2 8.6

(High grade, 20-year)

Large Company Stocks 10.4 12.4 20.4

(S&P 500 index)

Source: Ibbotson Associates, Stocks, Bonds, Bills, and Inflation, 2004 Yearbook.
1
The geometric mean is the compound rate of return over the 78 year sample period defined as
1
RGeometric= (V2003 V1926 ) 78 − 1 , where Vt is the value of the series in the respective year.
2
The arithmetic mean is the simple average of the 78 annual returns defined as
2003
RArithmetic = 1
78
∑ Rt .
t =1926
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Exhibit 6
DARDEN CAPITAL MANAGEMENT
THE MONTICELLO FUND
Selected interest rates
(April 1, 2004)

Security Yield (%)

Treasury constant maturities

1-month 0.95
3-month 0.93
6-month 1.02
1-year 1.23
5-year 2.87
10-year 3.91
20-year 4.77
Treasury inflation-indexed
5-year 0.53
10-year 1.48
Corporate industrial bonds (Moody’s seasoned)
Aaa 5.40
Baa 6.18

Source: Federal Reserve Statistical Release (www.federalreserve.gov/releases/h15/update).

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Exhibit 7
DARDEN CAPITAL MANAGEMENT
THE MONTICELLO FUND
Regression estimates for Boise Cascade
(Monthly returns over period 1999 to 2003)

Total return for Boise Cascade stock S&P 500

30%

20%

10%
Boise Cascade

0%

-10%

-20%

-30%
-30% -20% -10% 0% 10% 20% 30%
S&P 500

Ordinary least squares regression results

Regression equation:
(Return on Boise Cascade) = a + b* (Return on S&P500) + e

Results:
Coefficient Estimate t-statistic

a 0.7% 0.78

b 1.14 6.13