- The former was a listing of all stocks that met the original definition of small cap, with the elimination of any that were actively traded by institutional investors. This list typically was quite large—usually over 200 stocks—and was designed to provide a starting point for further investigation.
- The Individual Investors Shadow Stock Portfolio was previously named the Beginners Portfolio, and it is a listing that includes only micro-cap stocks with low price-to-book-value ratios. The portfolio reflects the research that shows that both value, as measured by the price-to-book-value ratio, and size, as measured by market capitalization, are important determinants of higher-than-average returns.
The Individual Investors Shadow Stock Portfolio has had several changes since the complete listing appeared in the November 2003 AAII Journal. Additions and sales appear in Table 2.
Table 2. Individual Investors Shadow Stock Portfolio: Update ADDITIONS As of 11/28/03 Company (Exchange: Ticker) Market
Strategic Distribution (Nasdaq: STRD) 44.3 0.87 Sands Regent (Nasdaq: SNDS) 20.9 0.56 WestCoast Hospitality (NYSE: WEH) 63.7 0.51 Books-a-Million, Inc. (Nasdaq: BAMM) 73.3 0.59 Lazare Kaplan Intl (ASE: LKI) 57.6 0.64 Imperial Parking Corp. (ASE: IPK) 43.3 0.62 Northwest Pipe Co. (Nasdaq: NWPX) 97.1 0.76 Stephan Co. (ASE: TSC) 18.9 0.49 SALES Company (Exchange: Ticker) Reason Aviall, Inc. (NYSE: AVL) grown too large Garden Fresh Restaruant (Nasdaq: LTUS) bought out Ag Services of America (NYSE: ASV) bought out Bought and Sold Bogen Communications (Nasdaq: BOGN), bought but then sold because of a company tender and planned delisting For a complete list of the stocks currently in the Individual Investors Shadow Stock Portfolio, go to www.aaii.com/modelportfolios.
There were other stocks that met most of our purchase criteria, but they were too thinly traded for our portfolio. If you are using the Individual Investors Shadow Stock Portfolio criteria either from the November 2003 Journal or as provided in our Stock Investor Pro stock screening software, you may have been able to buy other stocks based on your portfolio size.
James B. Cloonan is founder and chairman of AAII.
What's UP? AAII's Shadow Stock Portfolio
by James B. Cloonan
The Individual Investors Shadow Stock Portfolio has had an extremely good year as of this writing in early December (Table 1). By year end, it will most likely have beaten its best previous year, 1997, when it was up 44%.
|Table 1. The Individual Investors Shadow Stock Portfolio|
|Average Annual Return (%)||1-
|Individual Investors Shadow Stock Portfolio||13.3||32.8||65.1||77||80.9|
|Vanguard Index 500 Fund (S&P 500)||9||6.1||22.1||97||22.1|
* Through 11/30/2003.
** A measure of riskthe volatility of a portfolio relative to all stocks worldwide during normal market conditions. For example, a portfolio RiskGrade of 77 implies the portfolio has a risk 77% as high as the average risk of all equities in the world. RiskGrades for any portfolio can be found at the RiskGrades Web site (www.riskgrades.com); the Web site also provides the mathematical details of the approach.
***Through 11/30/2003; the return per unit of risk. This allows you to compare the returns of investments with different levels of risk by putting them on the same risk footing. The risk-adjusted return for a portfolio with lower risk relative to the market will be higher than its actual return, while the risk-adjusted return for a portfolio with higher risk relative to the market will be lower than its actual return. See box on p. 26 for more explanation.
The S&P 500 index is also up significantly, after its second-worst bearish period in modern times. But then, since World War II, the year preceding an election has always been a strong bull year—up, on average, 22%. The year during the election has also always been up—except for the last election in 2000.
Web Site Updates
Before I discuss the Individual Investors Shadow Stock Portfolio, I would like to remind you that you can get updated information on both the Individual Investors Shadow Stock Portfolio and the Individual Investors Mutual Fund Portfolio at our Web site (www.aaii.com; click on Model Portfolios under Tools). Since the AAII Journal has a long production time, when I report current returns here, they really arent current by todays standards. For that reason, we publish monthly updates on our Web site—AAII.com—right after months end for both portfolios. The updates include portfolio results as well as recent changes in portfolio composition.
The AAII Web site also provides the selection rules for each portfolio, so you dont have to reference previous Journal articles to see how the picks were made. It also includes important concepts I have discussed in AAII Journal articles. I will refer to these concepts from time to time in my column, but wont have the space for a complete explanation every time I mention them. The most important concept is risk-adjusted return. I discuss this concept and why it so important in the box at left. You can find this explanation later when you need it either by referring back to this issue or visiting the Model Portfolios area of AAII.com.
Throughout the discussions in my column and in my reporting of data, I talk about risk-adjusted returns.
You may well ask: I got the return I got. What does risk matter?
But risk DOES matter. It matters because, if you considered risk, you may have been able to get a higher return. Lower risk is directly exchangeable for higher return unless you are a gambler and not concerned about risk at all.
There are two ways the exchange of risk for return can take place. Lets use a simple example to illustrate both approaches. Both of these assume that each individual investor has established a suitable level of risk for their portfolio. Here, risk is measured by standard deviation—the amount by which most actual returns varied around the average return over a period of time; the higher the standard deviation, the greater the volatility of return and, therefore, the greater the risk.
First Approach: Borrowed Funds
However, you could also buy 150% of Portfolio A and have a risk level of 0.18—you would put 100% of your own money in Portfolio A, plus you would borrow an additional 50% and put it in Portfolio A. In this case, your return would be 12% on the original investment, plus 3.5% on the additional 50%, for a total return of 15.5% [The additional 3.5% is calculated by taking 50% of the return on Portfolio A less a 5% cost of borrowing: 50%(12% 5%).]
In this instance, the lower risk of Portfolio A was directly converted into a higher rate of return by increasing overall portfolio risk through the use of borrowed funds to increase the investment in stock.
Second Approach: Stocks and Treasuries
If you invest two-thirds of your portfolio in an S&P 500 index fund returning 12% with a risk of 0.18 and one-third of your portfolio in short-term Treasuries yielding 3%, with a risk level of zero, your portfolio will have a risk level of 0.12 (2/3 of 0.18 plus 1/3 of 0.00) and a return of 9% (2/3 of 12% and 1/3 of 3%).
However, for that same level of risk, 0.12, you could also invest 100% of your money in Portfolio A, and you will get a 12% return. In this case, adjusting your asset allocation allows you to convert risk reduction into increased returns by investing the portfolio in an all-stock portfolio rather than a mix of stocks and Treasuries.
Shadow Stocks: New and Improved
One other item you should note concerns the list of Shadow Stocks that has been carried in the AAII Journal each year. Many members complained that the listing had so many stocks that it was cumbersome and not very useful. For that reason, we are abandoning it for more expanded coverage of the Individual Investors Shadow Stock Portfolio. Thirty to 40 stocks should be a more meaningful quantity. We will perform much of the same kind of analysis on the smaller portfolio as we did on the old Shadow Stocks list.
I have had several questions about the difference between the Shadow Stocks that we previously listed each year in the February AAII Journal, and the new Individual Investors Shadow Stock Portfolio.