Featured Tickers:

NAESX , NWHM

The Model Shadow Stock Portfolio is reviewed quarterly to determine stock sales and additions. The quarterly portfolio review cycle is tied to the standard reporting cycle of most publicly traded firms in the U.S. Occasionally, a special situation arises that requires more immediate action.

Sell Alert in August

The acquisition announcement of New Home Company Inc. (NWHM) and the need to act on the tender offer generated a sell alert in August for the Model Shadow Stock Portfolio holding.

New Home Company announced on July 23, 2021, that it had entered into a definitive merger agreement to be acquired by funds managed by affiliates of Apollo Global Management Inc. Under the terms of the agreement, Apollo Funds would commence a tender offer to acquire all outstanding shares of New Home Company for $9.00 per share in cash. The acquisition will transform the company into a privately held enterprise.

The $9.00 purchase price represents an 85% premium to the closing stock price on July 22, 2021, of $4.86 per share and a 51% premium to the 90-day volume-weighted average price. The acquisition represents a strong immediate gain for holders of New Home Company, but at $9.00 per share Apollo Funds is able to acquire the firm with a book value of $11.22.

New Home Company announced second-quarter results shortly after it agreed to the merger and it started to meet the initial selection criteria again for the Model Shadow Stock Portfolio. The firm reported positive earnings for the quarter ending June 30, 2021, thereby rolling off the large nonrecurring loss from the quarter ending June 30, 2020, from its trailing 12-month earnings per share calculation.

Since the market price largely reflected the acquisition price of $9.00 per share, the model portfolio position in New Home Company was sold on August 16, 2021, and the proceeds were held in cash portfolio the until the next full quarterly review at the beginning of September. At the time of this writing, the tender offer was scheduled to expire at the end of the day on September 7, 2021. Members can sign up for email alerts regarding the Model Shadow Stock Portfolio at www.aaii.com/email.

Table 1 shows the current holdings in the portfolio.

Table 1. Model Shadow Stock Portfolio

Company	Ticker	Current Price ($)	52-Week High ($)	52-Week Low ($)	Market Cap ($ Mil)	P/E Ratio (X)	P/B Ratio (X)	Div Yield (%)	Notes
Company	Ticker	Current Price ($)	52-Week High ($)	52-Week Low ($)	Market Cap ($ Mil)	P/E Ratio (X)	P/B Ratio (X)	Div Yield (%)	Notes
Ampco-Pittsburgh Corp.	AP	5.53	8.81	2.82	105.6	23.5	1.29	0.0
Bassett Furniture Indus	BSET	24.68	37.00	8.90	241.8	13.1	1.52	2.3
Beazer Homes USA, Inc.	BZH	18.21	26.12	10.96	569.9	5.6	0.81	0.0
Big 5 Sporting Goods	BGFV	24.61	37.75	5.41	551.8	5.1	2.04	4.1
Container Store Group	TCS	12.30	19.31	3.31	621.5	6.7	1.63	0.0
Covenant Logistics Group	CVLG	22.14	23.97	13.23	372.0	10.5	1.18	0.0
Delta Apparel, Inc.	DLA	33.44	35.26	13.61	233.2	12.8	1.48	0.0
Ducommun Incorporated	DCO	55.8	65.40	30.76	661.2	24.0	1.96	0.0
Ennis, Inc.	EBF	20.4	22.24	15.18	532.5	19.5	1.75	4.9
Global Ship Lease Inc.	GSL	19.23	22.02	5.06	697.7	8.3	1.17	5.2
Hibbett Inc.	HIBB	91.22	98.35	24.71	1,460.60	8.8	3.39	1.1	near size limit, exceeds value limit
Hooker Furniture Corp.	HOFT	35.61	42.90	21.60	424.1	12.6	1.59	2.0
Hurco Companies, Inc.	HURC	33.69	38.83	27.72	222.4	136.4	0.94	1.7	qualifies as of 8/11/2021
Key Tronic Corp.	KTCC	7.14	10.48	6.35	76.8	14.1	0.62	0.0	qualifies as of 8/11/2021
Kimball Electronics Inc.	KE	23.15	29.99	11.00	577.8	21.7	1.36	0.0
Mesa Air Group Inc.	MESA	8.52	17.40	2.80	305.8	8.9	0.62	0.0	qualifies as of 8/11/2021
Orion Group Holdings Inc.	ORN	5.57	6.67	2.46	172.2	8.5	1.02	0.0	qualifies as of 8/11/2021
Pangaea Logistics Sol	PANL	4.97	5.39	2.08	226.8	9.2	1.05	2.8
Penn Virginia Corp.	PVAC	17.49	26.17	6.36	267.8	nmf	1.73	0.0	TTM adjusted earnings positive
Perion Network Ltd.	PERI	19.00	28.32	5.66	619.9	29.0	2.44	0.0
Rocky Brands Inc.	RCKY	50.54	69.00	22.51	368.4	14.4	1.97	1.1
SIFCO Industries Inc.	SIF	10.10	15.76	3.45	60.5	6.8	1.21	0.0
Strattec Security Corp.	STRT	43.40	67.28	17.04	168.7	7.4	0.93	0.0	qualifies as of 8/11/2021
Titan Machinery Inc.	TITN	29.89	35.24	11.75	673.1	24.4	1.75	0.0
Ultralife Corp.	ULBI	8.35	11.78	5.10	134.0	33.7	1.12	0.0
Vishay Precision Group	VPG	38.44	39.49	23.42	523.8	35.9	1.97	0.0
VSE Corporation	VSEC	47.31	53.44	27.50	601.0	65.6	1.50	0.8
New Home Company Inc. (NWHM) was removed from the portfolio on 8/16/2021. nmf = no meaningful figure Source: AAII Stock Investor Pro/Refinitiv. Data as of 8/11/2021. Approaching Size Limit: Stocks are sold if their market capitalization goes above three times the initial maximum criterion and there is a stock to replace it. The current market capitalization maximum for initial screening is $500 million. Stocks are marked “approaching size limit” if their current market cap exceeds 2½ times the initial criterion, or $1.25 billion. Approaching Value Limit: Stocks are sold once their price-to-book-value ratio goes above three times the initial criterion and there is a stock to replace it. The current initial price-to-book ceiling is 1.10. Stocks are marked “approaching value limit” if their current price-to-book-value ratio exceeds 2½ times the initial criterion, or 2.75. Earnings Probation: If last 12 months’ earnings 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. When available, adjusted (non-GAAP) earnings are used to put stocks on probation or sell them. Otherwise, earnings from continuing operations are used. The date is the fiscal quarter during which the company first reported negative trailing 12-month earnings. Qualifies 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. TTM Adjusted Earnings Positive: Trailing four-quarter GAAP earnings are negative, resulting in no meaningful figure for the price-earnings ratio. However, adjusted earnings for the period are positive.

Improvements in Year-Over-Year Results

When examining quarterly company results, it is normally best practice to compare a quarter to its counterpart last year. This is in contrast to annual results, which are examined sequentially, one after another. As we prepare for our upcoming Model Shadow Stock Portfolio quarterly review, we are examining the sales and earnings from the second quarter and comparing them to second-quarter results in the previous year.

Normally looking at year-over-year quarterly results as opposed to a sequential quarterly comparison helps to account for the typical seasonal swings that occur over the course of the year. A year-over-year comparison should help reveal the direction and strength of the company’s growth and the effectiveness of management.

Of course, the last year and a half have been nothing near normal. The impact of the coronavirus pandemic was strongly felt in the second quarter of 2020. This year, as companies report second-quarter results, we are seeing extremely strong year-over-year comparisons. For the most recent quarter, the average year-over-year revenue growth is 37.5%, while the average year-over-year earnings per share increase is 99.2% for the stocks currently in the Model Shadow Stock Portfolio. The median (or midpoint) value that helps to alleviate the impact of extreme numbers observed with averages is very similar. The median year-over-year quarterly revenue growth is 25.5%, while the median earnings per share growth is still 99.2%.

For the same stocks currently in the Model Shadow Stock Portfolio, last year for the second quarter they were reporting a drop in revenue of 15.1% on average (11.7% median) year over year and a decrease in earnings per share of 42.6% on average (26.2% median) compared to the second quarter of 2019.

Similar results can be observed by most stocks. For example, the stocks in the S&P 500 index have averaged a 37.9% year-over-year gain in revenue for the most recently reported quarter this year compared to a year-over-year decline of 10.2% last year. As you may have noticed, changes in earnings per share have been even more dramatic, with companies in the S&P 500 reporting an earnings gain of 107.8% average (62.7% median) year over year for the most recent quarter compared to a decline of 46.5% average (19.9% median) last year. The same pattern holds true for the stocks that compose the S&P MidCap 400 index and S&P SmallCap 600 index. Although generally smaller-cap stocks in the S&P indexes suffered greater year-over-year losses last year, the stocks in the S&P 500 are exhibiting slightly stronger year-over-year gains this year.

The coronavirus pandemic created a sudden and extreme decline in economic activity last year. As companies reported poor results, a number of Model Shadow Stock Portfolio holdings were placed on earnings probation. Other shadow stocks were suddenly showing losses under generally accepted accounting principles (GAAP) but also supplied adjusted earnings that were positive because nonrecurring events were excluded from the calculation. We are now seeing the Model Shadow Stock Portfolio holdings coming off earnings probation and notes are being removed regarding the disparity between adjusted earnings and GAAP earnings.

We have seen a recent shift of the best- and worst-performing sectors as worries over the impact of the delta variant grow. Defensive sectors performed the best recently, while cyclical sectors performed the worst.

Portfolio Performance

The small-cap stocks and value styles continued to underperform the large-cap growth style for the second month in a row ending July.

The Model Shadow Stock Portfolio lost 4.0% during July, lowering its year-to-date return to 41.0%. The S&P 500, as measured by the Vanguard 500 Index fund (VFINX), was up 2.4% during July and is now up 17.9% for the year. The Vanguard Small Cap Index fund (NAESX) gave up 1.4% during the month and is posting a 14.6% gain during 2021. Table 2 presents the portfolio’s performance figures against these comparisons over various time periods.

Table 2. Model Shadow Stock Portfolio Versus Benchmarks
(Through 7/31/2021)

Portfolio	Year-to-Date Ret (%)	Annual Return (%)				Ann’l Std Dev (%)
Portfolio	Year-to-Date Ret (%)	1-Year	5-Year	20-Year	Since Inception	Ann’l Std Dev (%)
Model Shadow Stock Portfolio	41.0	127.5	14.4	15.9	15.3	36.7
Vanguard 500 Index (VFINX)	17.9	36.3	17.2	8.7	10.4	18.2
Vanguard Small Cap Index (NAESX)	14.6	47.4	14.1	10.1	10.7	24.3
Data as of 7/31/2021.

There are many factors influencing the economy and the market beyond the coronavirus, yet the virus continues to strongly influence economic behavior globally and, in turn, the stock market. The highly contagious delta variant is throwing a monkey wrench into the post-pandemic reopening plans of many institutions. Counties that were able to contain the spread of the coronavirus with strict social distancing and quarantine mandates now find themselves dealing with strong outbreaks.

It serves as a reminder that it is the unexpected events and news that make major impacts on the market, as millions of market participants suddenly change their opinion of likely future outcomes. It is the “unknown unknowns” that drive the biggest surprises when they are revealed, as former Defense Secretary Donald Rumsfeld famously noted.