The performance of the Model Shadow Stock Portfolio in 2009 did not replace that of 2003 as the best year ever, but it came close with a return of 72.3% versus 73.1% for 2003. Unfortunately, even this unusually high return did not recover all that was lost in 2008, as can be seen in Figure 1.
We are still 14% below the pre-2008 level. We have to live with the reality that when you go down by 50%, you have to go up 100% to get back to where you were. Long term, the portfolio still has excellent performance, as can be seen in Table 1. The S&P 500 (represented by the Vanguard 500 Index fund) was up 26.5% for 2009 and is about 22% below its pre-2008 level.
Year-to-date (as of the end of February) the portfolio as well as the general market are about even, as can be seen in Figure 1 and Table 1, but there has been high volatility with a weak January and a strong February. The February strength is continuing into early March.
As shown in Figure 2, the number of stocks passing our initial screen dropped to 12 this quarter, which is down a bit. After a few more quarters, we will see if we can correlate the number of qualifying stocks with market behavior. Some of the qualifiers were already in the portfolio, and we made the choices here based primarily on lower price-to-book-value ratios.
Let me emphasize again that this is a real portfolio with real assets and not an advisory letter. We can buy stocks only when we sell stocks and free up funds.
|Annual Rate of Return (%)|
|Shadow Stock Portfolio||13.3||30.1||-50.8||-1.8||29.4||17.9||43.7||73.1||10.8||21.4||-7.7||0.0||-8.9||44.3||22.3||20.7||2.0||32.3|
|S&P 500 (VFINX)||6.6||3.0||-37.0||5.4||15.6||4.8||10.8||28.5||-22.1||-12.0||-9.1||21.1||28.6||33.2||22.9||37.4||1.2||9.9|
|Vanguard Small Cap (NAESX)||7.4||6.1||-36.0||1.2||15.6||7.4||19.9||45.6||-20.0||3.1||-2.7||23.1||-2.6||24.6||18.1||28.7||-0.5||18.7|
|DFA US Micro Cap (DFSCX)||9.2||1.8||-36.7||-5.2||16.2||5.7||18.4||60.7||-13.3||22.8||-3.6||29.8||-7.3||22.8||17.6||34.5||3.1||21.0|
|Data as of 5/31/2009.|
We sold two stocks, Greenbrier Companies (GBX) and L.S. Starrett Company (SCX), because they violated their probation. In addition, Allion Healthcare (ALLI) was bought out by H.I.G. Capital for $6.60 per share.
We added three stocks to the portfolio: CSS Industries (CSS), Lithia Motors, Inc. (LAD), and PC Mall, Inc. (MALL). These actions are summarized in Table 2. The revised portfolio is shown in Table 4.
|AeroCentury Corp. (ACY)||13.35||17.20||3.15||20.6||5.2||0.6||0.0|
|Alamo Group (ALG)||13.87||19.79||9.22||139.4||19.5||0.7||1.7||qualified as of 9/4/2009|
|Allion Healthcare (ALLI)||6.88||7.74||2.60||183.5||15.0||1.0||0.0|
|Avalon Holdings Corp. (AWX)||2.61||4.40||0.92||9.9||nmf||0.3||0.0||earnings probation (2009q2)|
|Cascade Corp. (CASC)||26.12||50.25||12.81||284.3||nmf||1.2||0.8||earnings probation (2008q4)|
|Ennis (EBF)||13.92||18.16||6.91||360.3||nmf||1.2||4.5||earnings probation (2008q4)|
|Flexsteel Industries (FLXS)||7.73||11.44||4.98||50.8||nmf||0.5||2.6||earnings probation (2009q3)|
|Greenbrier Companies (GBX)||13.12||22.45||1.86||224.3||nmf||1.2||0.0||earnings probation (2009q3)|
|Hastings Entertainment (HAST)||3.98||8.12||1.26||38.5||22.1||0.4||0.0|
|Jackson Hewitt (JTX)*||4.61||17.83||2.80||132.7||7.3||0.6||0.0|
|L.S. Starrett Company (SCX)||10.00||27.19||5.30||66.3||52.6||0.4||4.8|
|Marlin Business Servs (MRLN)||7.56||8.85||1.19||95.3||nmf||0.7||0.0||earnings probation (2008q4)|
|MedCath Corp. (MDTH)*||9.26||22.52||5.70||181.9||38.6||0.5||0.0||qualified as of 9/4/2009|
|OYO Geospace Corp. (OYOG)||20.32||52.54||9.00||121.2||18.0||1.0||0.0|
|Paragon Shipping (PRGN)||3.89||13.22||2.25||167.8||1.7||0.3||5.1|
|RCM Technologies (RCMT)||2.00||2.83||0.77||25.8||nmf||0.4||0.0||earnings probation (2008q4)|
|Saga Communications (SGA)||13.07||25.96||3.00||55.7||nmf||0.8||0.0||earnings probation (2008q4)|
|Shoe Carnival (SCVL)||14.81||18.45||6.05||191.3||40.0||0.9||0.0|
|Standard Motor Prods (SMP)||12.44||13.00||1.36||237.5||nmf||1.4||0.0||earnings probation (2008q4)|
|Standex Int’l Corp. (SXI)||18.07||30.00||7.85||222.4||nmf||1.3||1.1||earnings probation (2009q3)|
|SureWest Communic’ns (SURW)||12.65||18.50||6.20||179.2||1265.0||0.7||0.0||qualified as of 9/4/2009|
|Tufco Technologies (TFCO)||2.80||6.89||1.77||12.1||nmf||0.3||0.0||earnings probation (2009q2)|
|Twin Disc, Inc. (TWIN)||12.75||19.00||4.02||140.6||12.4||1.3||2.2|
|Willis Lease Finance (WLFC)||12.03||15.39||7.25||110.4||4.4||0.6||0.0|
|*Company is new to the model portfolio.|
|Source: AAII’s Stock Investor Pro/Thomson Reuters. Data as of 9/4/2009.|
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 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.
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.
There are three different definitions of earnings that are often used without distinguishing them from one another. We have been guilty of this sometimes, and I want to clear up how we use the three definitions. The three are:
GAAP Earnings. These are the earnings as calculated by
generally accepted accounting principles. It is the approach required on all filings with the SEC.
GAAP Earnings from Continuing Operations. The above GAAP earnings are generally adjusted to eliminate some gains or losses that are not ongoing—such as from discontinued activities.
Adjusted Earnings. These are earnings that have been adjusted to eliminate the impact of non-recurring events such as a markdown of inventory or goodwill. These are the earnings reported in the media, in press releases, and used in estimates of future earnings. Whenever they are used by a public company, there will be a footnote showing how GAAP earnings were adjusted. But adjusted earnings is what is generally meant when “earnings” are referred to.
We use GAAP earnings from continuing operations to screen stocks for inclusion in the portfolio initially. We do this because the figures have been reported to the SEC and are extremely dependable and it is somewhat more conservative.
We use adjusted earnings to put stocks on probation or sell them. We do this because the information appears much sooner than official filing data. In addition, I believe there is little reason to sell a stock based on something that has happened, won’t happen again, and is already in the price. In buying or selling, we use an approach that is most likely to reduce turnover, which is expensive in micro-cap stocks. We should point out that, in the majority of cases, there is no difference between GAAP and adjusted earnings.
Stock purchases must meet these criteria:
Stocks are sold if any of the following occur:
Right now, bullish and bearish sentiment seems about balanced. A recovery, unless suddenly aborted, seems well underway except for unemployment, which remains painfully high. While I think portfolios should remain at their long-term allocations, I do feel somewhat concerned that so many of the risk factors are under the control of other nations. This has been true for quite a while now, but the financial disturbances in the eurozone make it more apparent at this time.
Many pundits feel 2010 will be an average year for stocks, and the election cycle indicator for the second year after a presidential election would agree with an average performance of 11.5%. However, it’s getting hard to remember what average or normal means.
We will be reporting on the Model Shadow Stock Portfolio again in the July AAII Journal. In the meantime, you can follow the portfolio at AAII.com.
The Model Shadow Stock Portfolio is an actual portfolio with real dollars invested. Updates on portfolio activity are provided both in the AAII Journal in this column, and on our Web site at www.aaii.com/aaiiportfolios.