The current criteria for the Individual Investor’s Shadow Stock Portfolio is found under Stock Portfolio Rules. The current holdings are listed under AAII Shadow Stock Portfolio. The Notes column indicates if the stock would currently qualify as a buy, if it is on probation, or if it has some other special condition.
A major part of the process of selecting stocks under the rules can be accomplished by using the screens in AAII’s screening program, Stock Investor Pro. However, these same criteria can also be used in other screening programs that are available.
You can put stocks you select into a portfolio with screening software. You can then run the screen in successive periods on stocks you hold to see if they still qualify and check for sell criteria.
Having said all that, I want to make it clear that this is not intended to be an advisory service. If we all tried to buy these micro-cap stocks at the same time, we would distort the prices and reduce the effectiveness of the approach. Because of this, I feel the Individual Investor’s Shadow Stock Portfolio should be the beginning of the selection process—but not all of it.
Variations on the Philosophy
There are a number of ways the philosophy of the Individual Investor’s Shadow Stock Portfolio can be implemented without everyone buying the same 30+ stocks at the same time.
First, investors can use different timing. For the sample portfolio, I buy and sell quarterly unless I am making a rule adjustment. I usually buy early in November, February, May, and August. You can choose your own time period. Second, unless you have a continual inflow of money, you will come to the point where you are fully invested and can only buy when you have sold a holding. After a while, different investors will be on different schedules.
Third, the one part of the decision process that is open involves the liquidity of a particular equity. Depending on the size of your portfolio and when you tend to act, there will be a difference in your interpretation of which stocks can be purchased without distorting the price.
These are variations that occur naturally. However, I believe that you should also create your own variations, using the Individual Investor’s Shadow Stock Portfolio as a general guide. I have managed up to $1 million with these rules. If you are managing less than $100,000, you have more flexibility—I believe you can find reasonable bid/ask spreads in stocks with lower prices (but not below $2.00). You can also select companies with capitalizations that are below $17 million, perhaps as low as $10 million.
You also may want to try different criteria that use your own market knowledge or adjust your micro-cap portfolio to tie in with your other holdings. If you apply other criteria, you can increase the price-to-book ratio, but don’t go over 0.90 or it is no longer a true value stock.
The price-to-sales ratio can be increased to 1.5 and still be considerably below average.
You may have regional preferences. In the Individual Investor’s Shadow Stock Portfolio, foreign stocks and ADRs are eliminated, mainly for accounting reasons. However, you may wish to include them.
Micro-cap stocks should, in my opinion, be a part of your portfolio, and I will help you to manage that segment in future columns.
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