Applicability of TOPSIS Model and Markowitz Model

Abstract

The proper tool to select a company with the best financial performance is one of paramount importance before generating an optimal portfolio. The right company selection can reduce the influence of firm-specific risk which in turn can maximize the expected return on portfolio and minimize the portfolio risk. There are many literature which focus on generating portfolios using optimal Markowitz Model but did not focus much on effective methods on how to select stocks before forming the portfolio. In this paper, a method is introduced a method to select stocks before the formation of portfolio based on company’s financial performance through multi-criteria decision making model using Technique for Order of Preference by Similarity to Ideal Solution (TOPSIS) model. The objective of this study is to evaluate, compare and rank the company’s overall performance by sector using the TOPSIS model based on financial ratio data. Companies with the highest ranking by sector are then selected to form a portfolio. Next, the optimal portfolio is generated using the Markowitz model. When a company’s financial performance results were evaluated using the TOPSIS model, five companies are selected according to sector to form a portfolio. The findings show that the combination of TOPSIS and Markowitz models can help investors to make portfolio investment decisions more efficiently as compared to randomly selected stocks.