• AAII Model Portfolios
  • Model Shadow Stock Portfolio Reaches an All-Time High

    by James B. Cloonan

    Model Shadow Stock Portfolio Reaches An All Time High Splash image

    The run of strong performance in smaller-cap stocks that began in December 2011 has carried through January and February, and micro caps have led the way.

    The Model Shadow Stock Portfolio is up 17.2% year to date compared to 9.0% for the S&P 500 as measured by the Vanguard 500 Index fund (VFINX). The model portfolio is now at an all-time high.

    Other results and comparisons can be seen in Figure 1 and Table 3. We have added new columns to Table 3 to show the cumulative values of a $10,000 investment since inception of the Model Shadow Stock Portfolio in 1993. Notice the difference between the $185,923 present value of $10,000 invested 19+ years ago in the Model Shadow Stock Portfolio compared to $44,844 for VFINX and $56,358 for the Vanguard Small Cap Index fund (NAESX). What seems like a modest annual difference compounds very significantly over the years.

    The Model Shadow Stock Portfolio’s 16.5% annual average return since inception almost 20 years ago underscores a point made in Mark Hulbert’s article in the January 2012 AAII Journal (“Believing Performance Claims: A Triumph of Hope Over Experience”). Hulbert argued that 15% seems to be about the maximum long-term return possible without the additional techniques and leverage of hedge funds, which are not available to individual investors, or the ability to influence management behavior, which an investor like Warren Buffett has.

    Portfolio Changes

    Table 1 lists the current holdings in the Shadow Stock Portfolio. As shown in Table 2, we sold three stocks. Lithia Motors, Inc. (LAD) was sold because it violated our size limit of $600 million market capitalization. It almost quadrupled for us, and we wish it happiness in someone’s mid-cap portfolio. Paragon Shipping Inc. (PRGN) was sold because it violated earnings probation. SureWest Communications (SURW) has agreed to a buyout by Consolidated Communications. Current shareholders will have to choose between cash and new stock, but our general rule is to sell when the board of a company agrees to a takeover.

    The proceeds from these sales were used to make three purchases, listed in Table 2. We bought Ducommun Inc. (DCO), Medical Action Industries (MDCI) and Sterling Construction (STRL).

    Our first pass of stocks meeting the purchase criteria showed 17 qualifying stocks (Figure 2). Three of these were Chinese stocks, which we continue to eliminate because of data uncertainty, and three were stocks we currently own. The final selection was based on a combination of low price-to-book-value ratio, low market capitalization, and high liquidity.

    Company (Ticker) Current
    52-Week Market
    ($ mil)
    Addus Homecare Corp. (ADUS) 3.60 6.38 3.00 38.8 nmf 0.47 0.0  
    Alamo Group, Inc. (ALG) 26.87 30.37 19.71 320.1 11.2 1.16 0.9  
    Capital Senior Living (CSU) 8.57 10.91 5.44 237.2 53.6 1.37 0.0  
    CONN’S, Inc. (CONN) 13.26 14.75 4.14 424.0 nmf 1.23 0.0  
    CSS Industries (CSS) 19.60 22.40 14.98 190.6 21.3 0.76 3.1 qualified as of 2/29/2012
    Ducommun Inc. (DCO) 15.27 26.08 10.84 160.9 32.5 0.63 0.0 qualified as of 2/29/2012
    Ennis, Inc. (EBF) 16.76 20.25 12.08 436.7 11.5 1.20 3.7  
    Flexsteel Industries (FLXS) 17.10 17.18 13.04 115.7 10.6 0.87 2.3  
    Gilat Satellite Networks (GILT) 3.77 5.87 3.04 153.9 nmf 0.60 0.0  
    Hooker Furniture Corp. (HOFT) 12.01 13.71 7.96 129.6 30.8 1.01 3.3  
    Key Tronic Corp. (KTCC) 10.84 11.49 3.21 113.2 16.9 1.64 0.0  
    Kimball International (KBALB) 6.16 7.89 4.61 169.3 34.2 0.61 3.2 qualified as of 2/29/2012
    Marlin Business Services (MRLN) 15.70 16.58 9.37 201.1 32.0 1.14 1.5  
    Medical Action Industries (MDCI) 5.42 9.85 4.31 88.8 27.1 0.59 0.0 qualified as of 2/29/2012
    Mitcham Industries (MIND) 23.37 26.76 9.52 290.3 16.9 2.03 0.0 approaching value limit
    PC Connection, Inc. (PCCC) 8.94 12.92 6.73 236.4 8.3 0.86 0.0  
    PC Mall, Inc. (MALL) 6.05 10.98 4.80 72.8 10.1 0.67 0.0 qualified as of 2/29/2012
    RCM Technologies (RCMT) 5.48 5.93 3.98 70.0 16.6 0.98 0.0  
    Rex American Resources (REX) 30.67 31.83 13.36 255.2 39.8 1.19 0.0  
    Rocky Brands, Inc. (RCKY) 11.75 16.47 8.75 88.2 10.6 0.75 0.0 qualified as of 2/29/2012
    Saga Communications (SGA) 37.52 47.98 26.65 159.5 12.1 1.79 0.0  
    Shoe Carnival, Inc. (SCVL) 26.18 34.05 19.19 349.6 12.7 1.22 0.0  
    Standard Motor Products (SMP) 22.72 25.91 10.25 514.2 13.9 2.14 1.6 approaching size & value limit
    Standex Int’l Corp. (SXI) 38.21 43.92 25.11 483.6 13.0 1.96 0.7  
    Sterling Construction (STRL) 10.37 17.00 9.50 169.2 10.1 0.67 0.0 qualified as of 2/29/2012
    VOXX International* (VOXX) 12.79 14.56 4.69 295.1 9.3 0.72 0.0  
    Willis Lease Finance (WLFC) 14.47 14.82 9.91 170.8 11.0 0.61 0.0 qualified as of 2/29/2012

    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.

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

    Company (Ticker) Reason
    Ducommun Inc. (DCO)  
    Medical Action Industries (MDCI)  
    Sterling Construction (STRL)  
    Lithia Motors, Inc. (LAD) exceeded size limit
    Paragon Shipping Inc. (PRGN) negative earnings
    SureWest Communications (SURW) acquired by Consolidated Communications


      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 17.2 9.0 10.4 185,923 44,844 56,358
    Since Incep 16.5 8.1 9.4 185,923 44,844 56,358

    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.


    Since the 1930s, the third year in the election cycle had always been a slightly above-average 12% for the stock market. But four years ago the election year was one of the worst in history—down 37%. While the average election-year return since the Great Depression is still 10.3%, the recent behavior of stocks has departed from previous history, and the election cycle may not be much of a guide. One reason for this might be the growing importance of foreign factors: The election cycle has always been explained in terms of domestic spending activities, but other countries have different political and economic cycles.

    The numbers shown here may differ from your results depending on your requirement for average daily trading volume.

    I feel a bit more bullish than average, but not enough to change basic asset allocations. There is still a lot of uncertainty in the stock market. The election poses much uncertainty—not just about who will be nominated and/or elected, but about what the candidates’ plans really are. And the uncertainly extends beyond the presidential election to who will control the U.S. House and Senate.

    We will examine the Model Shadow Stock Portfolio again in the July AAII Journal, and you can follow any changes at here.


    Juan t from FL posted over 4 years ago:

    Do you recommend stop sell orders to minimize losses? Thanks

    Charles from IL posted over 4 years ago:

    Juan - Because of the nature of these type of stocks, they are best suited to a buy-and-hold strategy, rather than trading strategy. The holdings are monitored and we do have sell rules for the portfolio, which you can review at http://www.aaii.com/model-portfolios/stock-rules. -Charles Rotblut, AAII

    Barry from IL posted over 4 years ago:

    I am a new aaii member, and enjoy the newsletter. As a new member, I'm unfamiliar with aaii policies regarding the model portfolio. My question is can members buy the model portfolio, and if so, how? Thanks.

    Scott from CA posted over 4 years ago:

    The answer to your question is a tough one...there is another page in the forum where a few members have been discussing how they've managed to put the portfolio together, but it's not very clear.

    Essentially, YOU need buy all of the stocks that pass the screen and/or are in the portfolio. The problem is while you know WHICH stocks to buy to match the portfolio, you don't know in what amounts or at what price. You could simply buy equal amounts of every current holding - it says to start with equal amounts in the "rules" - but since you don't know how much the positions have run up, you won't really have the same portfolio.

    The way I am approaching this is to watch each of the holdings and for each that still meets the "buy" criteria, I'm looking for a good entry point - a day when they've fallen more than 3% for example. I just bought SGA last week after reading the research and seeing that it dropped 10% in one day. If I'm going to buy, a 10% pull-back seems like a pretty good start. The problem is it will take me 3 years at this rate waiting for each stock to catch a pull-back. Most of these have run up substantially this year and if you just buy the portfolio right now, you might have a 30% loss by the end of a year. The buy timing is crucial - just spend 10 minutes on Morningstar adjusting the timeframes of some funds to see the difference.

    When we find the answer to your question, we will be much happier! If you followed the rules closely, you could probably buy equal amounts of every stock in the current portfolio and do alright - of course, that violates the rules, since some of the current holdings don't meet the "buy" criteria...hence the dilemma. Good luck!


    Charles from IL posted over 4 years ago:

    Barry, you cannot directly invest in the portfolio. There is no mutual fund or ETF that mimics it. Rather you need to personally buy each stock to follow the portfolio. We suggest investing equal amounts in every stock if you want to track the portfolio. You can buy as few as 10 stocks from the portfolio if you prefer to start off with fewer holdings. See the user's guide for more information on how to follow the model portfolios: http://www.aaii.com/model-portfolios/getting-started -Charles Rotblut, AAII

    Gil from LA posted over 4 years ago:


    Getting in on a portfolio that was bought on a prior date, and getting in on a good price takes some planning.

    I like the portfolio I bought on February 29, which is up by over 16%, but would not buy it today. Last week, on the other hand, after two deep drawback days, I would have jumped on them.

    First of all, I had screened each of those stocks, and had studied how they behave well before I bought them. So, there was no question of the quality of those stocks.

    The second thing, however, is to buy on an overall dip. Today and yesterday we were coming out of a dip, but last Friday we were down low in one. There will be more dips. And the time for you to buy (if you know the stocks are quality buys) is to try to catch the next low.

    The best thing you could do to pick a good time -- until you become strongly experienced -- and if you use a discount brokerage (as most of us do when we've been at it for years and years) is find someone with experience that you trust, and get your bucket ready and tell you when it's likely a good time to place the bucket order.

    After years of trading, a person gets a sort of a feel for the way the U. S. exchanges are, in a sense, inhaling and exhaling. You want to strike at the bottom of an exhale.

    Having that feel, you just sort of know. But trying to teach that to a newbie, in less than a period of years, is pretty hopeless.

    Another problem is that even experienced traders fly by the seat of their pants, and don't always make the right call. While we strike out now and then, wise trading deals in getting it right most of the time.

    One good idea for a rookie investor is to join a stock investing club and ask for timing guidance. However, NEVER, let anyone else get into your actual account, or know your password. They do not have to know your details, or how much. They can provide you guidance on which stocks are good picks, and when is a good time to buy, without ever knowing how many shares you buy, or other details of your account.

    Good luck. Hope some of this is helpful.

    (I'm a twenty-year trading veteran, very cautious, and have a good record of earnings.
    And my annual goal is 30% gain, although I've averaged only about 12%/yr over past decade.
    Never get greedy or overly-trusting of those who would advise you. In AAII, you have come to about the best source of advice in the whole world.)

    John from FL posted over 4 years ago:

    Gil, Good Advice.

    Bruce from IL posted over 4 years ago:

    I have only been an AAII member since Jan, 2012. I have taken a hybrid approach to buying into the portfolio. I have bought the newly purchased stocks this year. And to supplement these portfolio purchases, I have a purchased a couple of the stocks on the qualification list which have not been purchased as part of the portfolio. The challenge here is that I must monitor the sell rules for these stocks on my own. But this seemed more prudent than buying stocks that had been in the portfolio for a while and may soon be sold.
    For my comfort level, this allows me to ease into the portfolio without also feeling under-invested.

    Gary from MI posted over 4 years ago:

    I am interested in putting about $100K into a portfolio of Shadow Stocks. In reading some of the comments it seems that you are recommending buying the full portfolio and probably base a full portfolio as being 30 stocks. I am believing that using 30 as target number of stocks buying the next 30 stocks recommended in the fixed dollar figure based on my target investment. You did not recommend picking up prior buys as the market has been rising decently. Is my thinking correct.

    Roger from CO posted over 4 years ago:

    So does the Shadow Stock theoretical purchase do any timing based on pull back in the month the purchase rules are met?
    Looks like Scott and Gil definite fined tuned the purchase rules, which makes sense.

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