• AAII Model Portfolios
  • Model Shadow Stock Portfolio Contests 2007 for Best Annual Return

    by James B. Cloonan

    Model Shadow Stock Portfolio Contests 2007 For Best Annual Return Splash image

    The Model Shadow Stock Portfolio is down from its level three months ago as reported in the October 2009 AAII Journal, but is still up 61.1% for the year to date (November 30), as compared with 24.1% for the S&P 500 (as measured by Vanguard 500 Index fund). Comparisons for other time periods and with other indexes are illustrated in Figure 1 and Table 1.

      Avg An’l
    Ret Since
    Incep (%)
    Annual Rate of Return (%)
    2008.0 2007.0 2006.0 2005.0 2004.0 2003.0 2002.0 2001.0 2000.0 1999.0 1998.0 1997.0 1996.0 1995.0 1994.0 1993.0
    Shadow Stock Portfolio 14.3 61.1 -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) 7.6 24.1 -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) 8.2 26.2 -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) 9.9 17.8 -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

    We still have a chance to rival 2003 as our best year ever, but will need a Santa Claus rally to get to +73.1%. By the time you read this, it will be decided. More importantly, we have not yet returned to the 2007 highs—neither the model portfolio nor the general market. At this time, it is hard to think of any driving force that would get us back to 2007 highs in the near term.

    I was looking at the percentage figures presented in Table 1 and thought it would be interesting to translate those percentages into dollars. If at the beginning of 1993, when the Model Stock Portfolio began, you had invested $100,000 into an S&P 500 index fund you would now have a total of $345,353. If you had invested it in the Model Shadow Stock Portfolio you would have a total of $959,714 (ignoring taxes and reinvesting returns). Small percentages can mean a lot in the long run.

    Qualifiers Level Off

    The number of stocks qualifying in our initial screen this quarter remained at 15—the same number as last quarter but still above our long-term average. Figure 2 shows the number of passing companies for each quarter over the past year. It is still too early to see if there is any correlation with changes in overall market value.

    Portfolio Changes

    Table 2 highlights the activity in the portfolio at the beginning of December. There were no sales. It looked like Cascade (CASC) would violate earnings probation, but it beat all analyst projections and reported positive earnings on December 2. Therefore, the stock remains in the portfolio though still on earnings probation.
    We had some reserves and dividend distributions and bought Capital Senior Living Corp. (CSU).

    Table 2. fourth Quarter 2009 Transactions


    Capital Senior Living Corp. (CSU)

    There are no changes to the portfolio rules, which are shown in Table 3. Table 4 shows the current portfolio.

    Market Seems Balanced

    When there are more potential positive things about the market, it doesn’t necessarily mean the market will go up. Conversely, potential bad things can lead to the market “climbing a wall of worry.” Right now, in my view, the potential good and bad are balanced, which means it is extremely difficult to build a case for exceptional strength or weakness.

    I would maintain normal allocations to the market for the time being. In the intermediate term, there is certainly concern about the national debt and the possibility of inflation. But, as I have commented before, even if we have a period of high inflation, it might help the stock market (at least in nominal dollars). Certainly it would be bad for the bond market and some segments of the stock market depending on the nature of the inflation.

    When you read this, we will be in the year 2010; the next review of the Model Shadow Stock Portfolio will be in the April 2010 AAII Journal. In the meantime, you can follow the portfolio at AAII.com each month. A happy and healthy New Year to all.

    Table 3. 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.)
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    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.
    • 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.

    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.
    • 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 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 $1 million.
    Company (Ticker) Current
    52-Week Market
    ($ Mil)
    AeroCentury Corp. (ACY) 16.15 24.95 3.15 24.9 6.3 0.67 0.0  
    Alamo Group (ALG) 14.87 18.04 9.22 149.4 20.7 0.77 1.6 qualified as of 11/30/2009
    Allion Healthcare (ALLI) 6.50 7.74 2.80 173.3 14.1 0.95 0.0  
    Avalon Holdings Corp. (AWX) 2.38 3.08 0.92 9.1 nmf 0.23 0.0 earnings probation (2009q2)
    Books-A-Million (BAMM) 7.07 15.00 1.86 111.2 8.3 1.05 2.8  
    Capital Senior Living (CSU)* 4.58 6.49 1.94 123.0 57.3 0.78 0.0 qualified as of 11/30/2009
    Cascade Corp. (CASC) 22.67 32.74 12.81 246.7 nmf 1.06 0.2 earnings probation (2008q4)
    Ennis (EBF) 14.49 17.35 6.91 374.2 nmf 1.24 4.3 earnings probation (2008q4)
    Flexsteel Industries (FLXS) 8.40 9.00 4.98 55.2 93.3 0.51 2.4 qualified as of 11/30/2009
    Greenbrier Companies (GBX) 10.73 14.67 1.86 183.3 nmf 0.86 0.0 earnings probation (2009q3)
    Hastings Entertainment (HAST) 4.41 4.74 1.26 42.6 24.5 0.43 0.0  
    Jackson Hewitt (JTX) 4.14 16.70 2.80 119.2 6.6 0.53 0.0  
    L.S. Starrett Company (SCX) 9.42 17.03 5.30 62.8 nmf 0.44 5.1 earnings probation (2009q3)
    Marlin Business Servs (MRLN) 7.05 8.74 2.49 89.1 nmf 0.60 0.0 earnings probation (2008q4)
    MedCath Corp. (MDTH) 7.34 13.63 5.70 144.2 30.6 0.38 0.0 qualified as of 11/30/2009
    OYO Geospace Corp. (OYOG) 32.55 34.67 9.00 194.1 28.8 1.62 0.0  
    Paragon Shipping (PRGN) 4.83 6.81 2.85 208.4 2.1 0.39 4.1  
    RCM Technologies (RCMT) 2.35 3.10 0.77 30.2 nmf 0.49 0.0 earnings probation (2008q4)
    Saga Communications (SGA) 12.99 17.70 3.00 55.4 nmf 0.80 0.0 earnings probation (2008q4)
    Shoe Carnival (SCVL) 18.09 19.54 6.05 234.1 48.9 1.08 0.0  
    Standard Motor Prods (SMP) 8.99 15.71 1.36 171.5 nmf 0.98 0.0 earnings probation (2008q4)
    Standex Int’l Corp. (SXI) 18.25 21.36 7.85 227.4 nmf 1.20 1.1 earnings probation (2009q3)
    SureWest Communic’ns (SURW) 8.71 14.83 6.20 123.4 nmf 0.46 0.0 earnings probation (2009q3)
    Tufco Technologies (TFCO) 3.19 5.60 2.10 13.8 nmf 0.38 0.0 earnings probation (2009q2)
    Twin Disc, Inc. (TWIN) 9.49 15.23 4.54 106.1 15.8 0.99 3.0  
    Willis Lease Finance (WLFC) 14.05 15.39 7.25 128.9 5.5 0.64 0.0  

    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 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.

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


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