Even with the pullback in August, it continues to be a very strong year for the Model Shadow Stock Portfolio. The portfolio is up 33.6% year-to-date as of August 31, 2013, compared to a gain of 16.0% for the S&P 500 index as measured by the Vanguard 500 Index fund (VFINX).
These results, as well as results for longer periods, can be seen in Figure 1 and Table 3. Almost every segment of the stock market seems very strong despite lots of disquieting events. I mentioned last quarter that although some of the economic concerns had lessened, we would probably find a new problem by the time this article was written. Sure enough, we got Syria and the problem of how to respond to their use of chemical weapons.
While the decision of what to do about Syria will be made before my January column, the budget crisis will be coming back into play over the next three months. So far, the market has taken a little step back with each negative event or prediction and then come bouncing back.
Interest rates keep going up. While this mainly affects bonds, there is an impact on those stocks whose price levels are maintained based on dividend yield. The Model Shadow Stock Portfolio does not include any such stocks. There is some feeling that as interest rates rise investors will switch from stocks to bonds, thereby putting downward pressure on stock prices. Interest rate increases, particularly at current low levels, are likely to signal continued economic recovery, which should be positive for stocks.
Table 1 lists the current holdings in the Model Shadow Stock Portfolio. We sold Saga Communications Inc.(SGA) because it no longer comes close to being a value stock. It may prosper in someone’s growth portfolio. The August pullback stopped Standard Motor Products (SMP) from breaking through the value or size limits, but it is quite close.
As shown in Figure 2, we were down to seven qualifying stocks this quarter using the liquidity requirements as described in the portfolio rules. We already owned three of the stocks. Two were Chinese, which we avoid, and we bought the other two.
|Fab Universal Corp. (FU)|
|LMI Aerospace, Inc. (LMIA)|
|Saga Communications, Inc. (SGA)||exceeded value limit|
The most important approach to reducing the negative impact of the spread is to minimize turnover. Our turnover ratio for the past 12 months was 13%, which really helps. This is why whenever there is a close decision about selling a stock, I avoid the transaction. When there are numerous stocks that qualify for purchase, the lower spread becomes a major tie-breaker.
There are also approaches to take when executing trades. It is important to realize that after you have done all the things recommended above, you still must pay a spread. Market makers are not going to make an efficient market without compensation that relates to the stock’s liquidity. If you place a buy order at a price between the bid and ask, there is a small chance that another investor will do the same thing on the sell side of the trade before the market moves. Generally, however, when you get an execution between the bid and ask it means that the market moved and you paid the new spread. If the market moved in the opposite direction, you won’t get a fill and may have to pay more than the old ask.
|Average Annual Return (%)||Cumulative Value of $10,000 ($)|
|Shadow||500||Small Cap||Shadow||500||Small Cap|
|Data as of 8/31/2013.|
Given that you must pay a spread, most of the time you don’t want to give anyone a free lunch. Never enter a market order. If you are willing to pay the ask price, and that is often wise, use that price as your limit price. A market order to buy is likely to get you 100 shares at the offer price and subsequently higher prices for additional shares. Also, you should have patience. Commissions are so low that it is often wiser to place multiple orders over time than a larger trade all at once.
We will see another earnings season before my next column, and this should impact stock prices more than most world events. General feelings about longer-term earnings also count, but they are strongly influenced, for right or wrong, by the most recent earnings trend.
President Obama’s choice of a new Federal Reserve chairman should take place soon and will have a short-term impact on interest rates and the stock market. The impact will be based on assumptions about future quantitative easing under the likely candidates. I hope it will be resolved before my next Model Shadow Stock Portfolio column in January 2014. In the meantime, you can follow portfolio news here.
|Company (Ticker)||($)||($)||($)||($ Mil)||(X)||(X)||(%)||Notes|
|Addus Homecare Corp. (ADUS)||21.18||23.71||4.70||231.1||21.0||2.07||0.0||approaching value limit|
|Alamo Group, Inc. (ALG)||45.36||47.61||28.59||549.2||17.4||1.69||0.6|
|Alpha & Omega Semicon (AOSL)||7.08||9.90||6.64||180.6||nmf||0.64||0.0||earnings probation (2013 Q4)|
|CSS Industries Inc. (CSS)||21.82||31.50||18.79||207.6||14.2||0.85||2.7|
|Ducommun Incorporated (DCO)||26.15||29.37||12.86||279.3||15.8||1.19||0.0|
|Ennis, Inc. (EBF)||17.81||19.42||13.90||466.9||15.8||1.25||3.9|
|Fab Universal Corp. (FU)*||4.04||5.70||2.25||84.1||16.2||0.58||0.0||qualified as of 8/31/2013|
|Flexsteel Industries (FLXS)||22.49||26.29||18.56||159.9||12.6||1.06||2.7|
|Gilat Satellite Networks (GILT)||4.75||6.20||3.06||199.6||nmf||0.84||0.0|
|Hardinge Inc. (HDNG)||14.49||16.88||8.56||170.4||12.1||1.06||0.6|
|Hooker Furniture Corp. (HOFT)||14.39||18.31||11.35||154.5||16.0||1.17||2.8|
|International Shipholding (ISH)||23.85||28.13||13.00||172.9||10.8||0.60||4.2||qualified as of 8/31/2013|
|Key Tronic Corp. (KTCC)||9.91||12.28||8.69||103.9||8.6||1.10||0.0|
|Kimball International (KBALB)||9.84||13.25||8.48||294.5||18.9||0.93||2.0|
|LMI Aerospace, Inc. (LMIA)*||12.09||23.20||12.02||155.4||11.3||0.73||0.0||qualified as of 8/31/2013|
|Marlin Business Services (MRLN)||24.36||25.97||15.43||314.8||20.6||1.66||1.8|
|Medical Action Industries (MDCI)||5.11||10.07||2.25||83.8||nmf||0.88||0.0|
|Mitcham Industries, Inc. (MIND)||17.56||18.79||11.51||224.5||15.7||1.25||0.0|
|Olympic Steel, Inc. (ZEUS)||25.98||29.48||15.43||284.5||nmf||0.96||0.3|
|PC Connection, Inc. (PCCC)||14.85||17.65||9.82||388.5||11.6||1.26||0.0|
|PCM Inc. (PCMI)||9.79||11.96||5.06||113.2||13.8||0.93||0.0|
|RCM Technologies, Inc. (RCMT)||5.70||6.72||5.00||70.5||17.3||1.14||0.0|
|Renewable Energy Group (REGI)||15.45||16.50||4.28||517.5||9.6||1.15||0.0|
|REX American Resources (REX)||29.54||41.00||14.43||241.2||NA||0.96||0.0|
|Rocky Brands, Inc. (RCKY)||15.89||19.37||10.84||119.4||11.3||0.94||2.5|
|Salem Communications (SALM)||7.74||10.14||4.62||192.0||nmf||1.00||2.6||earnings probation (2013 Q1)|
|Shoe Carnival, Inc. (SCVL)||25.39||27.22||18.80||519.7||16.8||1.65||0.9|
|Standard Motor Products (SMP)||30.66||38.05||16.57||704.9||14.2||2.13||1.4||approaching size & value limits|
|TravelCenters of America (TA)||7.61||12.50||4.18||225.0||10.9||0.59||0.0||qualified as of 8/31/2013|
|VOXX International (VOXX)||12.16||15.00||5.55||292.1||9.9||0.65||0.0|
|Willis Lease Finance (WLFC)||14.04||16.28||11.70||124.4||40.1||0.54||0.0||qualified as of 8/31/2013|
|*Company is new to the portfolio. Added 9/3/2013.|
|Source: AAII’s Stock Investor Pro/Thomson Reuters. Data as of 8/31/2013.|
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 $240 million. Stocks are marked “approaching size limit” if their current market cap exceeds 2½ times the initial criterion, or $600 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.
Stock purchases must meet these criteria:
Stocks are sold if any of the following occur:
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.