- The best stocks for individual investors are not the same stocks that are best for institutions, and
- Success comes more from concern for the overall portfolio than for individual stocks.
- 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 firms 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.)
- 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 stocks price-to-book-value ratio goes above three times the initial criterion.
- Market capitalization goes above three times the initial maximum criterion.
- After two years, sell if not qualifying as a buy currently. (But do not sell until there is a qualified stock to buy.) The two years should be measured from the last time the stock qualified, not from when you purchased it.
- 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.
- Be careful if the average daily number of shares traded is not four times the amount needed for your position. It may be too difficult to get in and out of the position, but you may be able to grow the position gradually and sell gradually.
- 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 isnt 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.
- 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 receiptsup to 5% of the portfolios valueare 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 dont put more than 10% of your funds in each additional stock. More than 20 stocks is not needed until the portfolio exceeds $1 million.
Results Not Yet Final, But So Far, Election-Year Returns Have Yet to Appear
by James B. Cloonan
The bear market continues and is now about a year old, with the downturn in smaller company stocks a few months older.
Prior to this year, the Model Shadow Stock Portfolios worst year was 1998, when the portfolio was down 8.9% (Table 1 shows the annual performance of the Model Shadow Stock Portfolio since inception). Year-to-date (as of the end of August), we are a bit lower than 1998, at 10.2%.
|Table 2. Third-Quarter 2008 Transactions|
|Alloy, Inc. (ALOY)||negative earnings|
|Edge Petroleum Corp. (EPEX)||negative earnings|
|ILX Resorts Inc. (ILX)||negative earnings|
|Nu Horizons Electronics (NUHC)|
|Providence Service Corp. (PRSC)|
Table 2 highlights the activity in the portfolio since May 31, 2008, Table 3 shows the current holdings of the Model Shadow Stock Portfolio and their status, and Table 4 shows the latest portfolio rules.
We have changed our buy and sell schedule somewhat. We formerly did our buying and selling during the last week of the three-month period. Several times we missed important information that came out in the month-end data, so we are now making our changes the first week of the following month, which will be September, December, March, and June.
Our last quarter sales were:
At the same time, we bought:
There are no changes in the rules or modifications of the qualifying levels for price-to-book ratio or capitalization size.
One other change in the portfolio occurred because of a rights offering. PGT, Inc. (PGTI) had a rights offering whereby stockholders could buy one share for every four shares held at a price of $4.20 per share, which was almost $1.00 below market. Under the offering, you could simply buy the extra shares at the discounted price and hold the stockwhich is what we didor, you could have subscribed to the new shares and sold an equivalent number of shares after August 4 and locked in the $1.00 per share profit. For example, if you owned 400 shares on August 4 you had the right to buy 100 additional shares at $4.20 up until September 4 (unless extended). After August 4 you could have sold 100 of your original shares at $5.20 and bought 100 shares at $4.20 under the offer. We bought and held the additional shares of PGTI, even though it was on probation, because of the discount relative to the price and because earnings estimates are positive for the next quarter.
We added the information on the rights offering to our Shadow Stock Portfolio description on AAII.com as soon as we had the information. However, if you own the stock your stockbroker should have notified you of the offering and sent you a prospectus. At the very least, your portfolio should have shown the addition of a new securitythe purchase right. This right was not transferable or saleable.
A Down Market for Now
There is little I can add to what I have already said about the market in discussing both the Model Shadow Stock Portfolio and Model Mutual Fund Portfolio. Its a down marketunusual for an election yearand it wont be over til its over.
I continue to recommend a long-term view because market turns, in either direction, are often sudden.
We will be updating the Model Shadow Stock Portfolio in the January 2009 AAII Journal, but in the meantime you can follow it at AAII.com.
By January, we will have a new year and a new presidentand, we hope, a better economy and stock market.
Late Note: Just before press time, Gehl Company (GEHL) announced it was being bought out. Since there is board approval and the market price is close to the $30 offer, we are selling our shares.
|About the Model Shadow Stock Portfolio|
The Model Shadow Stock Portfolio provides guidance for investing in the promising micro-cap value sector of the market. It reflects AAII Founder James B. Cloonans investing philosophy, which holds that:
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.
|Model Shadow Stock Portfolio Rules|
Purchase and Sales Rules
Stock purchases must meet these criteria:
Stocks are sold if any of the following occur:
Stock Order Guidance