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Model Shadow Stock Portfolio: Up Modestly During an Atypical Year

by James B. Cloonan

Model Shadow Stock Portfolio: Up Modestly During An Atypical Year Splash image

After being in negative territory for a number of months, the Model Shadow Stock Portfolio showed a positive return year-to-date as of the end of November.

And after lagging for most of 2011, it finally passed the S&P 500 with a return of 1.5% compared to the S&P 500’s 0.9%, as measured by the Vanguard 500 Index fund (VFINX). Results for the past 19 years can be seen in Figure 1 and Table 2.

It is hard to get excited about such a small return, particularly in a pre-election year, when the average return on the S&P 500 index since the Great Depression has been 21.7%. But it looks like we may avoid a pre-election year negative return, a scenario that has not occurred since 1931.

The economy seems to be gradually recovering, and if it were not for the problems in Europe, the stock market might have come closer to experiencing at least a normal year. As of early December, there are indications of a positive push that may bring us closer to an average year for the general market, which would be 12.6%.

It has been a year full of problems—political stalemate, unemployment, record bad weather and the euro crises. In addition, the usual government spending spree to win votes gave way to budget concerns. Many feel it is a miracle that the market has performed as well as it has.

Portfolio Changes

Table 1 lists the current holdings of the Model Shadow Stock Portfolio. As shown in Table 3, two holdings were sold this quarter. Both Books-A-Million (BAMM) and Hastings Entertainment (HAST) were sold because of negative earnings while on probation.

The proceeds from these sales did not provide sufficient funds for a full new position of average size, so additional shares of Audiovox (VOXX) and Rex American Resources (REX) were purchased. Both of these issues currently qualified and had somewhat less than an average dollar value.

There were 16 stocks that passed the initial screening, as shown in Figure 2. Two of these were stocks already held and three were Chinese companies, which we continue to avoid.

Outlook

There are some bullish signs out there. Small-cap stocks, which have been lagging, are beginning to catch up. Employment is improving, even if at a slow pace, and economic activity is looking better. Europe, while moving to improve its debt load, is still worrisome, and there are a lot of unknowns. I continue to feel that normal long-term portfolio allocations are appropriate.

We will be reviewing the Model Shadow Stock Portfolio in the April 2012 issue of the AAII Journal. In the meantime, it is kept up to date online, and you can check its performance at AAII.com.

 

 

 

Company (Ticker) Current
Price
($)
52-Week Market
Cap
($ mil)
P/E
Ratio
(X)
P/B
Ratio
(X)
Div
Yield
(%)
 
High
($)
Low
($)
 
Notes
Addus Homecare Corp. (ADUS) 3.80 6.38 3.25 40.9 nmf 0.50 0.0 earnings probation (2011q3)
Alamo Group, Inc. (ALG) 28.40 29.27 19.71 338.3 11.8 1.23 0.8  
Audiovox Corporation (VOXX) 7.24 8.98 4.69 167.1 6.2 0.42 0.0 qualified as of 11/30/2011
Capital Senior Living (CSU) 7.43 10.91 5.44 205.7 46.4 1.19 0.0  
CONN’S, Inc. (CONN) 11.28 11.72 3.15 359.6 nmf 1.00 0.0 earnings probation (2010q2)
CSS Industries (CSS) 21.25 21.98 14.98 207.0 26.6 0.86 2.8  
Ennis, Inc. (EBF) 14.85 20.25 12.08 386.9 9.5 1.06 4.2  
Flexsteel Industries (FLXS) 14.12 19.69 13.04 95.5 9.4 0.73 2.8 qualified as of 11/30/2011
Gilat Satellite Networks (GILT) 3.65 5.89 3.04 149.0 365.0 0.55 0.0  
Hooker Furniture Corp. (HOFT) 9.76 14.75 7.96 105.3 33.7 0.83 4.1  
Key Tronic Corp. (KTCC) 4.80 6.11 3.21 50.1 9.6 0.77 0.0 qualified as of 11/30/2011
Kimball International (KBALB) 6.07 7.89 4.61 166.6 55.2 0.60 3.3  
Lithia Motors, Inc. (LAD) 22.21 23.84 12.50 575.6 16.7 1.67 1.3 approaching size limit
Marlin Business Services (MRLN) 13.00 13.74 9.37 166.6 30.2 1.03 1.8  
Mitcham Industries (MIND) 14.64 20.00 8.65 181.7 15.7 1.16 0.0  
Paragon Shipping Inc. (PRGN) 0.77 3.66 0.66 45.6 nmf 0.09 0.0 earnings probation (2011q3)
PC Connection, Inc. (PCCC) 10.13 11.65 6.73 267.8 9.6 0.98 0.0  
PC Mall, Inc. (MALL) 5.72 10.98 4.80 68.9 9.5 0.63 0.0 qualified as of 11/30/2011
RCM Technologies (RCMT) 5.17 5.93 3.98 65.9 15.7 0.94 0.0  
Rex American Resources (REX) 18.38 18.90 13.36 173.2 23.9 0.71 0.0 qualified as of 11/30/2011
Rocky Brands, Inc. (RCKY) 9.49 16.47 8.93 71.1 6.4 0.62 0.0 qualified as of 11/30/2011
Saga Communications (SGA) 35.30 40.45 21.99 150.1 11.4 1.76 0.0  
Shoe Carnival, Inc. (SCVL) 23.78 34.05 19.19 315.6 11.5 1.12 0.0  
Standard Motor Products (SMP) 19.53 19.77 10.25 442.0 12.0 1.84 1.4  
Standex Int’l Corp. (SXI) 31.93 40.43 25.11 403.8 11.1 1.60 0.9  
SureWest Communications (SURW) 11.49 17.83 8.72 161.9 71.8 0.59 3.5 qualified as of 11/30/2011
Willis Lease Finance (WLFC) 11.64 14.20 9.91 143.4 8.9 0.49 0.0 qualified as of 11/30/2011
 

Explanation of Notes

Approaching Size Limit: Stocks are sold if their market capitalization goes above three times the initial maximum criterion. The current market capitalization maximum for initial screening is $200 million. Stocks are marked “approaching size limit” if their current market cap exceeds 2½ times the initial criterion, or $500 million.

Approaching Value Limit: Stocks are sold once their price-to-book-value ratio goes above three times the initial criterion. The current initial price-to-book ceiling is 0.80. Stocks are marked “approaching value limit” if their current price-to-book-value ratio exceeds 2½ times the initial criterion, or 2.00.

Earnings Probation: If the last 12 months’ earnings from continuing operations are negative, the stock is put on probation; if a subsequent quarter has negative earnings prior to 12-month earnings becoming positive, the stock is sold. The date within the parentheses lists the fiscal quarter during which the company first reported negative trailing 12-month earnings.

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Qualified as of: Stock still qualified as a buy when the screen was run with current data. Stocks that don’t currently qualify as a buy are held until they meet one of the sell rules.

See the Shadow Stock Portfolio area of AAII.com for more information.

 

Model Shadow Stock Portfolio Rules

Purchase and Sales Rules

Stock purchases must meet these criteria:

  • No bulletin board or pink sheet stocks will be purchased.
  • Price-to-book-value ratio must be less than 0.80. (Figure will change gradually with changes in overall market values.)
  • Market capitalization must be between $17 million and $200 million. (Figure will change gradually with changes in overall market values.)
  • The firm’s last quarter and last 12 months’ earnings from continuing operations must be positive.
  • No financial stocks or limited partnerships will be purchased.
  • No stocks on foreign exchanges or ADRs will be purchased because of different accounting and/or withholding tax on dividends.
  • The share price must be greater than $4.
  • In order to reduce trading by avoiding stocks that are forever marginal, any stock that was sold within two years will not be rebought.
  • Note second item under Stock Order Guidance concerning spreads when buying shares.
  • Price-to-sales ratio must be less than 1.2. (Figure may change gradually with changes in overall market values.)
  • Eliminate any company that failed to file a 10-Q (quarterly) report in the last six months.

Stocks are sold if any of the following occur:

  • If last 12 months’ earnings from continuing operations are negative, the stock is put on probation; if a subsequent quarter has negative earnings prior to 12-month earnings from continuing operations becoming positive, the stock is sold.
  • The stock’s price-to-book-value ratio goes above three times the initial criterion.
  • Market capitalization goes above three times the initial maximum criterion.

Stock Order Guidance

  • These rules are for general guidance. Your own experience, market conditions and the size of the position will impact your own decisions. The results in the model portfolio were obtained while sometimes paying more.
  • Market orders are not used. Instead, if the quoted bid-ask spread is less than 2% (ask price minus bid price, divided by ask price), place a limit order at the ask price for a buy and at the bid price for a sell. If the bid-ask spread is more than 2%, try to place a limit order between the bid and ask prices to keep transaction costs low. If necessary, build a position gradually. With low commissions, it is often better to place partial orders than to try to establish a large position all at once. Be patient.
  • The average daily dollar volume should be at least four times the amount needed for your position. This will ensure liquidity to get in and out of the position, even if you need to grow the position gradually and sell gradually. This will result in a varying number of qualifying stocks for each investor.
  • For NASDAQ stocks, it appears to be better to use day orders. If the order is not filled, it is placed again with a slight adjustment. For NYSE and Amex stocks, good-till-canceled (GTC) orders are used to keep a place in line in the specialists’ books. If the market isn’t close to the desired price, the price is adjusted in a few days with a new GTC order.
  • If price changes cause a stock to become ineligible (due to changes in price-to-book-value ratio or market capitalization) when only part of the order has been filled, stocks already purchased are kept but the balance of the order is canceled.

Management Rules

  • Equal dollar amounts are invested in each stock initially.
  • Decisions are made only at the end of each quarter. In order to react to the majority of earnings reports as soon as possible, quarterly reviews are made in February, May, August, and November.
  • Best judgment is used for tenders or mergers, but all criteria must be obeyed.
  • At the end of a quarter, if receipts from stocks sold exceed requirements for new purchases, the excess receipts—up to 5% of the portfolio’s value—are kept in cash until the next quarter. If the excess receipts are greater than 5% of the total portfolio value, the amount above 5% is distributed to smaller holdings that still qualify as buys. Efficient quantities are purchased: If over 10% of the portfolio is in cash, the price-to-book-value ratio can be moved up, but never over 0.90.
  • At the end of a quarter, if receipts from stock sales are insufficient to buy all newly qualifying stocks, purchases are made in order of lowest bid/ask spreads.
  • Note that if you are managing your own portfolio, it should consist of at least 10 stocks. If you are developing the portfolio gradually, you can do it stock by stock, but don’t put more than 10% of your funds in each additional stock. More than 20 stocks is not needed until the portfolio exceeds $1 million.

 

  Average Annual Return (%)
Model
Shadow
Stock
Portfolio
Vanguard
500
Index
(VFINX)
Vanguard
Small Cap
Index
(NAESX)
 
DFA US
Micro Cap
(DFSCX)
1993 32.3 9.9 18.7 21.0
1994 2.0 1.2 -0.5 3.1
1995 20.7 37.4 28.7 34.5
1996 22.3 22.9 18.1 17.6
1997 44.3 33.2 24.6 22.8
1998 -8.9 28.6 -2.6 -7.3
1999 0.0 21.1 23.1 29.8
2000 -7.7 -9.1 -2.7 -3.6
2001 21.4 -12.0 3.1 22.8
2002 10.8 -22.1 -20.0 -13.3
2003 73.1 28.5 45.6 60.7
2004 43.7 10.8 19.9 18.4
2005 17.9 4.8 7.4 5.7
2006 29.4 15.6 15.6 16.2
2007 -1.8 5.4 1.2 -5.2
2008 -50.8 -37.0 -36.0 -36.7
2009 72.3 26.5 36.1 28.1
2010 45.4 14.9 27.7 31.3
YTD 1.5 0.9 -3.0 -4.1
Since Incep 15.5 7.7 9.0 10.6
 
The numbers shown here may differ from your results depending on your requirement for average daily trading volume.
Company (Ticker) Reason
Buy  
Audiovox Corp. (VOXX) purchased additional shares with excess cash 
Rex American Resources (REX) purchased additional shares with excess cash 
 
Sell  
Books-A-Million (BAMM) negative earnings
Hastings Entertainment (HAST) negative earnings

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James B. Cloonan is founder and chairman of AAII.


Discussion

Dennis from UT posted over 2 years ago:

This is Jan 6 2012 When do you update portfolio performance and all models?


Charles from IL posted over 2 years ago:

Dennis, we update the performance for our three model portfolios on the 15th of each month. Because of the holiday, performance this month may not be updated until Jan 17, however. -Charles Rotblut


Kevin from MA posted over 2 years ago:

Why do I see SURW as well as other holdings listed as a holding "qualified as of 11/30/11" yet I see no transaction history for this or similar purchases in the 4th qtr of 2011?
How should I maintain current with activity you generate in the portfolio if it is not listed in the transaction file?


Charles from IL posted over 2 years ago:

Kevin-The qualified designation means the stock currently meets the purchase requirements for the portfolio. It is a designation for those members who either want to buy fewer than all of the stocks in the portfolio or want to see which stocks currently meet the purchase requirements. It does not mean that more shares were added to the portfolio. -Charles Rotblut, AAII


Edward from NC posted over 2 years ago:

I am a new member and want to get started with the stock portfolio. Would it be wise to start by buying the quilifing stocks


Charles from IL posted over 2 years ago:

Hi Edward, the stocks listed as qualifying in the portfolio are the ones most closely match the purchase criteria for the portfolio. We suggest you hold at least 10 of the stocks if you intend to follow the portfolio. More information can be found at http://www.aaii.com/model-portfolios/getting-started. -Charles, AAII


Charles from IL posted over 2 years ago:

Hi Edward, the stocks listed as qualifying in the portfolio are the ones that most closely match the purchase criteria for the portfolio. We suggest you hold at least 10 of the stocks if you intend to follow the portfolio. More information can be found at http://www.aaii.com/model-portfolios/getting-started. -Charles, AAII


Robin from FL posted over 2 years ago:

Why don't you show the purchase date and price of each issue in Table 1 to provide clearer context for the individual returns ?


Charles from IL posted over 2 years ago:

Robin, we show transaction data in the Model Portfolios section of the website at http://www.aaii.com/model-portfolios/stock-transaction-history. -Charles Rotblut, AAII


John from MI posted over 2 years ago:

How often do you add and/or subtract from the Model Shadow Stock Porfolio and what are the dates that we can see the changes on the web site?


Jean from IL posted over 2 years ago:

Changes are made to the Model Shadow Stock Portfolio once a quarter. They are posted to the Transaction History page of the Shadow Stock section in the Model Portfolios area around the middle of the month in March, June, September, and December (and are reported in the January, April, July and October issues of the AAII Journal). The posting of changes is usually announced in both the AAII Investor Update email and the Weekly Features email. Go to www.aaii.com/email to subscribe (free to members).


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