• The model portfolio has a compound annual average return of 13.6% since inception in 1993
• Small-cap stocks remain attractively priced relative to large-cap stocks
• The second-quarter review of holdings prompts several changes

After a rough April, market sentiment improved in May, helping to push most indexes back into positive territory for the year. The Model Shadow Stock Portfolio is up 1.7% for the year as of May 31 after gaining 5.1% during May. The S&P 500 index, as measured by the performance of the Vanguard 500 Index fund (VFINX), is up 11.2% for the first five months of the year after gaining 5.0% in May. The Vanguard Small Cap Index fund (NAESX) is up 4.4% for the year after gaining 4.0% during the month.

Small-cap stocks remain attractively priced relative to large-cap stocks. The median price-to-book-value (P/B) ratio of the companies in the S&P SmallCap 600 index is 1.71, well below the 3.41 median price-to-book ratio for the companies in the S&P 500. The S&P SmallCap 600 normally trades at a discounted multiple relative to the S&P 500. The discount has averaged 0.66 since 1998 and is currently 0.50. The stocks in the Model Shadow Stock Portfolio are even cheaper, with a median price-to-book value of 0.82.

Attractive relative valuation comparisons of small-cap stocks also hold true if price-earnings (P/E) ratios are considered. The median price-earnings ratio of the companies in the S&P SmallCap 600 is 17.4, below the 24.9 median ratio for the companies in the S&P 500. The stocks in the Model Shadow Stock Portfolio have a median price-earnings ratio of 13.7. Stocks in the S&P SmallCap 600 are trading with a median price-earnings ratio that is currently 0.70 times that observed with S&P 500 stocks. When it comes to the price-earnings ratio, small-cap stocks have not always traded at a discount compared to large-cap stocks. Small caps traded at a premium from 2004 through 2017 but are now trading at a discount compared to the 0.97 average observed since 1998.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 13.6% versus the Vanguard 500 Index fund’s gain of 10.3% per year on average over the same period. Over the same period, the Vanguard Small Cap Index fund has an average annual gain of 9.8%. Figure 1 shows performance over these and other time periods. 

Quarterly Review and Deletions

The primary Model Shadow Stock Portfolio selection criteria target the intersection of the smallest 10% of domestic stocks as measured by market capitalization, along with the “cheapest” 10% of domestic stocks as measured by the price-to-book ratio. These decile breakpoints are determined by examining domestic companies that are listed on the New York Stock Exchange (NYSE) and then applying the size and value breakpoints for stocks listed on all domestic exchanges.

This 1% intersection (10% and 10% combined) constitutes the primary initial selection universe. Research conducted by Eugene Fama and Kenneth French (Journal of Finance, June 1992) showed that the smaller the market cap of a company, the higher its stock returns. In addition, the lower the ratio of market price to book value, the higher the returns. The highest returns came from those stocks that were in the lowest market-cap decile and the lowest price-to-book decile.

The Model Shadow Stock Portfolio is reviewed quarterly to determine portfolio deletions and additions. The quarterly review cycle is tied to the reporting cycle of most firms and limits costly portfolio turnover. Table 1 shows the stocks currently making up the model portfolio. AAII’s fundamental stock screening and research database Stock Investor Pro, with data as of June 7, 2024, was used for the market decile analysis. After conducting the quarterly review of the Model Shadow Stock Portfolio, there are five deletions and five additions, as summarized in Table 2. 

Value Analysis

The price-to-book cutoff has decreased slightly from 0.84 in March to 0.83. The current initial qualifying maximum price-to-book ratio for the Model Shadow Stock Portfolio is 0.90 and we left it unchanged. Qualifying stocks must have a price-to-book ratio of 0.90 or lower when added to the model portfolio. There are currently 1,197 exchange-listed securities with a price-to-book ratio less than or equal to 0.90, down from 1,229 in March. Stocks in the model portfolio are removed for valuation if they exceed three times the initial maximum price-to-book ratio at the time of a quarterly portfolio review, which equates to a level of 2.70 (0.90 (AP) 3).

As of June 10, 2023, Covenant Logistics Group Inc. (CVLG) had the highest price-to-book ratio in the Model Shadow Stock Portfolio. Its price-to-book ratio of 1.56 is below the 2.70 value used to remove stocks from the model portfolio. Therefore, no stocks are being deleted this quarter for exceeding the valuation limit of the model portfolio.

Size Analysis

We examined the market-cap levels of domestic companies listed on the NYSE to determine the size cutoff for the lowest decile when adding stocks to the model portfolio. The lowest decile market-cap level decreased from $297 million in March to $287 million using data in Stock Investor Pro as of June 7, 2024. We left the maximum initial qualifying market-cap value unchanged at $300 million. There are currently 1,443 exchange-listed securities with a market cap between $30 million and $300 million, down from 1,460 in March. Holdings are removed if their market cap goes above three times the initial criterion at the time of the quarterly review, which equates to a level of $900 million ($300 (AP) 3).

Portfolio Deletion: Global Ship Lease, Inc. 

Global Ship Lease Inc. (GSL) is a U.K.-based containership owner, leasing ships to container shipping companies under industry-standard, fixed-rate time charters. Global Ship Lease has the largest market cap of $1.02 billion in the model portfolio, above the $900 million maximum level. Global Ship Lease is being removed from the model portfolio because it exceeded the maximum market cap at the time of review. Global Ship Lease was added to the Model Shadow Stock Portfolio on December 14, 2020, at a price of $10.64 per share. It was deleted on June 11, 2024, at $28.51 per share, for a gain of 168.0%.

Earnings Analysis

The other factor that leads to portfolio turnover is tied to negative earnings. If a company has trailing 12-month earnings from continuing operations that are negative, the stock is placed on probation; if a subsequent quarter has negative earnings prior to trailing 12-month earnings becoming positive, the stock is deleted. When available, adjusted (non-GAAP) earnings are used to put stocks on probation or remove them. These are earnings that have been adjusted to eliminate the impact of nonrecurring events such as markdown of inventory or goodwill.

Ampco-Pittsburgh Corp. (AP), Bassett Furniture Industries Inc. (BSET) and Big 5 Sporting Goods Corp. (BGFV) were on earnings probation at the start of the latest earnings season.

Portfolio Deletion: Ampco-Pittsburgh Corp. (AP)

Ampco-Pittsburgh (AP) manufactures and sells highly engineered, high-performance specialty metal products and customized equipment used in a variety of industries.

Ampco-Pittsburgh went on earnings probation when it reported a fourth-quarter 2023 adjusted loss of $0.773 per share, which pushed its trailing 12-month adjusted earnings into the red. Ampco-Pittsburgh reported a first-quarter 2024 loss of $0.138 per share on May 14, 2024.

Ampco-Pittsburgh is being removed from the portfolio due to negative earnings. Ampco-Pittsburgh was added to the Model Shadow Stock Portfolio on December 14, 2020, at a price of $5.61 per share. It was deleted on June 11, 2024, at $1.09 per share, for a loss of 80.6%.

Portfolio Deletion: Bassett Furniture Industries Inc. (BSET)

Bassett Furniture Industries (BSET) is a retailer, manufacturer and marketer of home furnishings sold through a network of company-owned and licensee-owned stores under the Bassett Home Furnishings name.

Bassett Furniture Industries went on earnings probation when it reported a fourth-quarter 2023 adjusted loss of $0.47 per share, which pushed its trailing 12-month adjusted earnings into the red. Bassett Furniture Industries reported a first-quarter 2024 loss of $0.14 per share on April 3, 2024.

Bassett Furniture Industries is being removed from the portfolio due to negative earnings. Bassett Furniture Industries was added to the Model Shadow Stock Portfolio on December 13, 2019, at a price of $15.39 per share. It was deleted on June 11, 2024, at $14.055 per share, for a loss of 8.7%.

Portfolio Deletion: Big 5 Sporting Goods Corp. (BGFV)

Big 5 Sporting Goods (BGFV) is a sporting goods retailer in the western U.S.

Big 5 Sporting Goods went on earnings probation when it reported a fourth-quarter 2023 adjusted loss of $0.388 per share, which pushed its trailing 12-month adjusted earnings into the red. Big 5 Sporting Goods reported a first-quarter 2024 loss of $0.38 per share on April 30, 2024.

Big 5 Sporting Goods is being removed from the portfolio due to negative earnings. Big 5 Sporting Goods was added to the Model Shadow Stock Portfolio on December 5, 2017, at a price of $7.03 per share. It was deleted on June 11, 2024, at $3.1308 per share, for a loss of 55.5%.

Acquisition

Portfolio Deletion: L.S. Starrett Co.

L.S. Starrett Co. is an industrial company serving the metalworking, construction, machinery, equipment, aerospace and automotive markets.

L.S. Starrett announced on March 11, 2024, that it entered into a definitive merger agreement to go private with an affiliate of MiddleGround Capital in an all-cash transaction for $16.19 per share. The purchase price represented an approximately 63% premium to the closing stock price on March 8, 2024, the last trading day prior to the transaction announcement.

The merger was completed on May 24, 2024. L.S. Starrett was added to the Model Shadow Stock Portfolio on December 13, 2023, at a price of $10.10 per share. It was removed on May 24, 2024, at $16.19 per share, for a gain of 60.3%.

Quarterly Additions

As of June 10, 15 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, unchanged from May. AAII members can see and research which companies are currently passing the initial selection criteria in the Shadow Stock Ideas table on AAII.com. The list of new Shadow Stock Ideas is updated daily—Tuesday through Saturday.

Two qualifying stocks were already in the Model Shadow Stock Portfolio at the time of the review. The remaining 13 stocks were examined to ensure adequate liquidity, timely financial filings and appropriate industry and foreign considerations. The Shadow Stock Portfolio Rules on AAII.com provide guidance on factors to consider when selecting stocks for your portfolio.

With the proceeds from the deletions, as well as the cash held in the portfolio, the portfolio was able to take positions in five new companies.

Portfolio Addition: Alpha Pro Tech, Ltd. (APT)

Alpha Pro Tech Ltd. (APT) develops, manufactures and markets a line of protective apparel garments, face masks and face shields, as well as a line of construction weatherization building products for the housing market. Alpha Pro Tech began as a face shield company in 1989 and made various acquisitions that added face masks, disposable protective garments, automated shoe covers and lamination capabilities. In 2005, Alpha Pro Tech developed a line of construction weatherization products, namely house wrap and synthetic roof underlayment for the building supply market.

Alpha Pro Tech has a book value per share of $5.46 as of March 31, 2024. If you wish to stay within the 0.90 price-to-book maximum, you should pay no more than $4.914 per share ($5.46 (AP) 0.90). However, if the stock price has moved up since passing the Shadow Stock screen, you can still purchase the stock unless the price-to-book ratio goes above 1.00, which equates to a price of $5.46 per share. To calculate the maximum purchase price based on the maximum desired price-to-book ratio, multiply the current book value per share ($5.46 for Alpha Pro Tech) by the maximum price-to-book ratio to be considered for the Model Shadow Stock Portfolio (currently 0.90, or 1.00 for loosened consideration).

Portfolio Addition: American Vanguard Corp. (AVD)

American Vanguard Corp. (AVD) is a diversified specialty and agricultural products company. The company develops and markets products for crop protection and management, turf and ornamentals management and public and animal health.

American Vanguard has a book value per share of $13.35 as of March 31, 2024. If you wish to stay within the 0.90 price-to-book maximum, you should pay no more than $12.015 per share ($13.35 (AP) 0.90). However, if the stock price has moved up since passing the Shadow Stock screen, you can still purchase the stock unless the price-to-book ratio goes above 1.00, which equates to a price of $13.35 per share.

Portfolio Addition: Castor Maritime Inc. (CTRM)

Castor Maritime Inc. (CTRM) is a Cyprus-based company engaged in the ocean transportation of dry-bulk cargoes worldwide through the ownership and operation of bulk carrier vessels. Castor Maritime owns a fleet of 10 vessels, with an aggregate capacity of 0.7 million deadweight tonnage (dwt), currently consisting of three Kamsarmax vessels, five Panamax dry-bulk vessels and two 2,700 twenty-foot equivalent unit (TEU) containership vessels. Castor Maritime completed a 1-for-10 reverse stock split on March 27, 2024, meeting the minimum $1.00 per share bid price requirement for maintaining its listing on the Nasdaq exchange.

Castor Maritime has a book value per share of $49.96 as of March 31, 2024. If you wish to stay within the 0.90 price-to-book maximum, you should pay no more than $44.964 per share ($49.96 (AP) 0.90). However, if the stock price has moved up since passing the Shadow Stock screen, you can still purchase the stock unless the price-to-book ratio goes above 1.00, which equates to a price of $49.96 per share.

Portfolio Addition: DMC Global Inc. (BOOM)

DMC Global Inc. (BOOM) owns and operates Arcadia Products, DynaEnergetics and NobelClad, three asset-light manufacturing businesses that provide differentiated products and engineered solutions to segments of the construction, energy, industrial processing and transportation markets.

DMC Global has a book value per share of $20.90 as of March 31, 2024. If you wish to stay within the 0.90 price-to-book maximum, you should pay no more than $18.81 per share ($20.90 (AP) 0.90). However, if the stock price has moved up since passing the Shadow Stock screen, you can still purchase the stock unless the price-to-book ratio goes above 1.00, which equates to a price of $20.90 per share.

Portfolio Addition: Nortech Systems Inc. (NSYS)

Nortech Systems Inc. (NSYS) is a provider of design and manufacturing solutions for complex electromedical devices, electromechanical systems, assemblies and components. Nortech Systems primarily serves the medical, aerospace & defense and industrial markets. Its design services span concept development to commercial design, and include medical device, software, electrical, mechanical and biomedical engineering. Headquartered in Maple Grove, Minnesota, Nortech Systems currently has seven manufacturing locations and design centers across the U.S., Latin America and Asia.

Nortech Systems has a book value per share of $13.04 as of March 31, 2024. If you wish to stay within the 0.90 price-to-book maximum, you should pay no more than $11.736 per share ($13.04 (AP) 0.90). However, if the stock price has moved up since passing the Shadow Stock screen, you can still purchase the stock unless the price-to-book ratio goes above 1.00, which equates to a price of $13.04 per share.

Next Portfolio Review

The next quarterly review of the Model Shadow Stock Portfolio will take place in early September 2024, after most of the holdings have announced their earnings. Any changes to the portfolio will be announced at the time they are made in our Model Shadow Stock Portfolio Update emails (sign up at www.aaii.com/email).