• AAII Model Portfolios
  • Despite Uncertainty, Model Shadow Stock Portfolio Still Positive for 2012

    by James B. Cloonan

    Despite Uncertainty, Model Shadow Stock Portfolio Still Positive For 2012 Splash image

    May has taken away much of the stock market gain of the first four months.

    This pullback has impacted the Model Shadow Stock Portfolio as well as the general market. The portfolio was up 9.1% for the year as of May 31, 2012, compared to a 5.1% year-to-date return for the S&P 500 index, as measured by the Vanguard 500 Index fund (VFINX). But the Model Shadow Stock Portfolio had been up over 22% for the year in mid-March.

    The stock market hates uncertainty, and uncertainty is with us. In addition to an extension of the eurozone problems because of the government transition in Greece, we have domestic uncertainty as well. The economic picture is not clear. No one knows what the Federal Reserve will do. And election debating points seem to be more important to our government than making decisions about taxes, budgets, Social Security, and Medicare.

    Longer-term results and comparisons can be seen in Figure 1 and Table 3. While the pullback in May was disappointing, the portfolio movement for the year-to-date is still upward, and a bit above our average results.

    No Changes to Portfolio

    Table 1 lists the current holdings in the Model Shadow Stock Portfolio.

    Table 2 shows that there were no transactions for the second quarter of 2012. We had no sales of holdings this period, and as a result there were no purchases. Remember this is a real portfolio, and we can’t buy if we don’t sell.

    Nineteen stocks passed the initial screen, which is about the average number of passing companies since 2008, as shown in Figure 2. Of the 19, four were Chinese stocks and three were already in our portfolio.

    The number of Chinese stocks appearing in our screen dropped in the past two quarters, and I wondered what had happened to them. They appeared when I eliminated the minimum $4.00 share price constraint. Not all, but a significant number of the Chinese passing companies from a year ago or so have dropped below $4.00 in price in recent quarters.

    Remember, the number of qualifying stocks will change based on your liquidity requirements. In our initial screen, we may require more liquidity than you would need, and so you might find more than 19 stocks. The Stock Order Guidance section of the Model Shadow Stock Portfolio Rules box discusses this issue.

    Company (Ticker) Current
    52-Week Market
    ($ Mil)
    Addus Homecare Corp. (ADUS) 3.99 6.38 3.00 43.0 nmf 0.49 0.0  
    Alamo Group, Inc. (ALG) 30.97 34.23 19.71 369.2 11.2 1.33 0.8  
    Capital Senior Living (CSU) 9.88 10.40 5.44 278.2 141.1 1.58 0.0  
    CONN’S, Inc. (CONN) 17.49 19.83 4.97 564.6 nmf 1.58 0.0 approaching size limit
    CSS Industries (CSS) 19.04 22.40 14.98 185.2 11.4 0.76 3.2  
    Ducommun Inc. (DCO) 9.03 23.54 8.43 95.3 nmf 0.46 0.0  
    Ennis, Inc. (EBF) 14.22 18.90 12.08 371.9 11.8 1.01 4.9  
    Flexsteel Industries (FLXS) 20.11 22.00 13.04 136.7 11.6 1.00 2.0  
    Gilat Satellite Networks (GILT) 3.19 5.20 3.04 131.7 nmf 0.51 0.0  
    Hooker Furniture Corp. (HOFT) 10.98 13.99 7.96 118.5 23.4 0.93 3.6  
    Key Tronic Corp. (KTCC) 9.69 13.16 3.21 101.4 11.0 1.36 0.0  
    Kimball International (KBALB) 6.88 7.19 4.61 260.8 45.9 0.68 2.9  
    Marlin Business Services (MRLN) 14.41 16.58 9.37 183.3 26.2 1.05 1.7  
    Medical Action Industries (MDCI) 4.31 9.80 4.25 70.6 21.6 0.47 0.0 qualified as of 5/31/2012
    Mitcham Industries (MIND) 18.90 26.76 9.52 240.4 9.5 1.51 0.0  
    PC Connection, Inc. (PCCC) 8.98 12.92 6.73 237.1 8.1 0.85 0.0  
    PC Mall, Inc. (MALL) 5.32 8.40 4.80 64.0 38.0 0.57 0.0  
    RCM Technologies (RCMT) 5.68 6.16 3.98 72.2 17.8 1.00 0.0  
    Rex American Resources (REX) 18.42 33.95 14.15 154.6 7.3 0.61 0.0 qualified as of 5/31/2012
    Rocky Brands, Inc. (RCKY) 13.23 14.33 8.75 99.3 11.7 0.84 0.0  
    Saga Communications (SGA) 34.90 47.98 26.65 148.3 10.8 1.55 0.0  
    Shoe Carnival, Inc. (SCVL) 21.18 22.70 12.79 432.6 15.7 1.45 0.0  
    Standard Motor Products (SMP) 13.51 25.91 10.25 311.1 4.9 1.10 2.7  
    Standex Int’l Corp. (SXI) 40.69 46.05 25.11 513.7 11.9 1.98 0.7 approaching size limit
    Sterling Construction (STRL) 9.00 14.60 8.54 146.9 nmf 0.71 0.0 earnings probation (2012 Q1)
    VOXX International (VOXX) 9.86 14.56 4.69 230.8 9.0 0.54 0.0  
    Willis Lease Finance (WLFC) 12.74 14.82 9.91 118.4 11.7 0.52 0.0 qualified as of 5/31/2012

    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.

    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.

    Company (Ticker) Reason
    No buys for second quarter.  
    No sells for second quarter.  

    Purchase and Sales Rules

    Stock purchases must meet these criteria:

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    • 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.

    Stock Split

    Model Shadow Stock Portfolio holding Shoe Carnival, Inc. (SCVL) split 3-for-2.

    You need to adjust the purchase price and the number of shares in your records if you hold this stock.

    Your broker should have made the adjustments on your account records.

      Average Annual Return (%) Cumulative Value of $10,000 ($)
    Small Cap
    Small Cap
    1993 32.3 9.9 18.7 13,230 10,989 11,870
    1994 2.0 1.2 -0.5 13,492 11,118 11,810
    1995 20.7 37.4 28.7 16,291 15,282 15,204
    1996 22.3 22.9 18.1 19,927 18,775 17,959
    1997 44.3 33.2 24.6 28,756 25,010 22,375
    1998 -8.9 28.6 -2.6 26,188 32,168 21,790
    1999 0.0 21.1 23.1 26,187 38,945 26,831
    2000 -7.7 -9.1 -2.7 24,163 35,418 26,116
    2001 21.4 -12.0 3.1 29,325 31,160 26,926
    2002 10.8 -22.1 -20.0 32,506 24,259 21,535
    2003 73.1 28.5 45.6 56,268 31,174 31,360
    2004 43.7 10.8 19.9 80,843 34,530 37,587
    2005 17.9 4.8 7.4 95,353 36,180 40,376
    2006 29.4 15.6 15.6 123,363 41,832 46,687
    2007 -1.8 5.4 1.2 121,166 44,083 47,227
    2008 -50.8 -37.0 -36.0 59,582 27,764 30,217
    2009 72.3 26.5 36.1 102,665 35,120 41,130
    2010 45.4 14.9 27.7 149,238 40,358 52,529
    2011 6.3 2.0 -2.8 158,701 41,155 51,067
    YTD 9.1 5.1 4.3 173,189 43,248 53,246
    Since Incep 15.8 7.8 9.0 173,189 43,248 53,246
    The numbers shown here may differ from your results depending on your requirement for average daily trading volume.

    Looking Ahead

    Over the next few months, we will be treated to what seems destined to be one of the bitterest election campaigns in recent history. Both parties have record campaign funds to give the fight maximum exposure. Remember that it is a campaign, and that not all the bad things are true. Our economy and the equities market will survive the battle, and the results, no matter what the outcome is.

    We will be examining the Model Shadow Stock Portfolio in the October 2012 AAII Journal; in the meantime you can follow updates here.


    Vince Rappa from NJ posted over 4 years ago:

    I would like to invest in the Model Shadow Stock Portfolio at this time. Any advise or changes now?

    Bruce Jacobson from TN posted over 4 years ago:

    To Vince Rappa:
    The way I look at the Shadow Portfolio leads me to avoid those stocks that have been in the portfolio for over a year. I looked at the older purchases and learned that most of them had achieved higher values than they had at purchase time. Therefore, my strategy is to buy the recent recommendations and wait for them to appreciate. The older entries into the portfolio often have already had some of their run and may not rise much further. It will take awhile to accumulate the entire portfolio but you will be holding the stocks that are more likely to increase in value.

    Dick Bureson from TX posted over 4 years ago:

    That sounds like a realistic approach for a new subscriber looking to get into the Shadow Portfolio, but How do you know when a stock was brought into the portfolio & at what price?

    Bruce Jacobson from TN posted over 4 years ago:

    To Dick Bureson The way that the Shadow Portoflio invests is described in the AAII Magazine and also on the Web site. Essentially, they screen a large number of stocks to find those that meet their criteria for investing. Then at the end of each quarter they select up to three stocks to add to the portfolio and buy them. At some time they may make the purchase a few weeks before the end of the quarter. The identity of each stock that they buy is published in the month following the usual investment time and the price that was paid is also listed. Exceptions do occur. In the most recent quarter no purchases were made since the portfolio was full and did not have space for new additions. This was a consequence of not making room by selling matured stocks.

    Joseph E Mersnik from OH posted over 3 years ago:

    I am new to AAII.

    I counted 29 stocks in the current Shadow Portfoilo. Comments on the following observations would be appreciated:

    How does one proceed to implement a Shadow Portfolio if for example an investor were to allocate $100,000 to a Shadow Portfolio investment and assuming there would be 27 stocks in it, by extrapolation then, does one make a dollar purchase of approximately $3500 for each equity?.......and do so within a short period of time in order to create the diversification mass?

    If I am overlooking something please advise.
    Thank you,


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