A continued climate of high interest rates and concerns over a potential recession helped to fuel a stock sell-off in August. Large-cap and growth stocks held up better than the broad market. The Model Shadow Stock Portfolio is up 13.6% for the year. The S&P 500 index, as measured by the performance of the Vanguard 500 Index fund (VFINX), is up 18.6% for the first eight months of the year. The Vanguard Small Cap Index fund (NAESX) is up 10.3% for the year.

In the large-cap segment, growth stocks are up 24.2% year to date for 2023, while large-cap value stocks are up 12.8%. Mid-cap growth stocks are up 12.2% for the year, while mid-cap value stocks are up 7.7% for the year. Small-cap growth stocks are up 8.6% year to date, while small-cap value stocks are up 5.9%.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 13.7% versus the Vanguard 500 Index fund’s gain of 9.9% per year on average over the same period. Over the same period, the Vanguard Small Cap Index fund has an average annual gain of 9.7%. Figure 1 shows performance over these and other time periods.

Quarterly Review & Changes

Table 1 shows the stocks currently making up the model portfolio. The Model Shadow Stock Portfolio is reviewed quarterly to determine portfolio deletions and additions, a practice put in place since the portfolio’s inception in 1993. After conducting the quarterly review of the Model Shadow Stock Portfolio, there are three deletions and two additions, as summarized in Table 2.

The review begins with an examination of the prevailing valuation segments of the marketplace. The Model Shadow Stock Portfolio selection criteria targets the “cheapest” 10% of domestic stocks as measured by the price-to-book-value (P/B) ratio. The decile breakpoint for value is determined by examining price-to-book levels of domestic companies listed on the New York Stock Exchange (NYSE) and then using the price-to-book breakpoint for stocks listed on all domestic exchanges.

The NYSE price-to-book lowest decile cutoff did not change since the last quarterly review, so we are maintaining the initial qualifying maximum price-to-book ratio at 0.90. Qualifying stocks must have a price-to-book ratio of 0.90 or lower. Stocks in the model portfolio are removed for valuation if they exceed three times the minimum initial price-to-book ratio at the time of a quarterly portfolio review.

As of September 13, 2023, Core Molding Technologies Inc. (CMT) had the highest price-to-book ratio in the Model Shadow Stock Portfolio. Its price-to-book ratio of 1.66 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.

We then examined market-capitalization levels of the companies listed on the NYSE to determine the size cutoff for the lowest decile when stocks are added to the model portfolio. The lowest decile market-cap maximum declined from $285 million in June to $270 million. We are, however, keeping the maximum initial qualifying market-cap value at $300 million. The maximum market cap for inclusion in the Model Shadow Stock Portfolio is $300 million, and holdings are removed if their market cap goes above three times the initial criterion at the time of the quarterly review: $900 million.

VSE Corp. (VSEC) has the highest market cap in the portfolio, with a value of $893.3 million as of September 13, 2023. Its market cap was just below the removal level of $900 million, so no stocks are being deleted this quarter for exceeding the market-cap limit of the model portfolio.

The other factor that leads to portfolio turnover is tied to negative earnings. If a company has negative trailing 12-month earnings from continuing operations, the stock is placed on probation; if a subsequent quarter has negative earnings prior to trailing 12-month earnings becoming positive, the stock is removed. 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. These are earnings reported in the press and by firms that compile consensus estimates. The LSEG I/B/E/S adjusted earnings reported in AAII’s Stock Investor Pro are used for Model Shadow Stock Portfolio decisions when they are available. If the company is not tracked by LSEG I/B/E/S analysts, then we use the normalized earnings as determined by LSEG and reported in Stock Investor Pro.

Coming into this quarterly review, Container Store Group Inc. (TCS), Hooker Furnishings Corp. (HOFT), SigmaTron International Inc. (SGMA), Strattec Security Corp. (STRT) and VOXX International Corp. (VOXX) were on earnings probation.

Hooker Furnishings reported positive adjusted earnings per share of $0.07 for the quarter. While the figure was not strong enough to pull trailing 12-month earnings into positive territory, the stock will stay in the model portfolio. However, it remains on earnings probation.

SigmaTron International reported normalized earnings per share of $2.095, pushing trailing 12-month earnings into the black and taking the stock off earnings probation.

Container Store Group, Strattec Security and VOXX International reported quarterly losses during the quarter and were removed from the Model Shadow Stock Portfolio on September 14, 2023.

Portfolio Deletion: Container Store Group Inc. 

Container Store Group (TCS) is a specialty retailer of organizing solutions, custom spaces and in-home organizing services in the U.S. Container Store Group noted that its first-quarter 2023 performance reflects the ongoing challenging macroeconomic environment. The company reported a net loss of $11.8 million, or a loss of $0.24 per share, compared to net income of $10.5 million, or $0.21 per diluted share, in the prior-year quarter.

Container Store Group was added to the Model Shadow Stock Portfolio on March 8, 2018, at a price of $4.82 per share. It was removed on September 14, 2023, at $2.28 per share, for a loss of 52.7%.

Portfolio Deletion: Strattec Security Corp.

Strattec Security (STRT) designs, develops, manufactures and markets automotive access control products primarily to North American customers. Strattec Security noted that despite higher net sales in fourth-quarter 2023, operating profit results were lower than the prior-year quarter due to higher manufacturing input costs and a stronger Mexican peso against the U.S. dollar. The company reported a loss of $0.69 per share, compared to diluted earnings per share of $0.10 in the prior-year quarter.

Strattec Security was added to the Model Shadow Stock Portfolio on August 31, 2017, at a price of $31.66 per share. It was deleted on September 14, 2023, at $24.00 per share, for a loss of 24.2%.

Portfolio Deletion: VOXX International Corp.

VOXX International (VOXX) is an international manufacturer and distributor in the automotive electronics, consumer electronics and biometrics industries. The company noted that its primary near-term obstacle is the global economy as it continues to impact consumer spending. The global retail environment in particular is tough as it has seen the ongoing consumer pivot from spending on durable goods to more travel and luxury goods.

VOXX International is being removed from the portfolio due to the Model Shadow Stock Portfolio’s negative earnings rule. VOXX International was added to the Model Shadow Stock Portfolio on September 9, 2021, at a price of $10.50 per share. It was deleted on September 14, 2023, at $8.10 per share, for a loss of 22.8%.

Quarterly Additions

Running the numbers, 27 stocks met the initial selection criteria for the Model Shadow Stock Portfolio as of September 13, 2023, up from 23 one month ago. 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 Shadow Stock Ideas is updated daily—Tuesday through Saturday.

Eight qualifying stocks were already in the Model Shadow Stock Portfolio at the time of the review. The remaining 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 removing the three stocks along with the cash held in the portfolio, two stocks were added at roughly the average position size for the existing holdings in the tracking portfolio.

Portfolio Addition: Natural Gas Services Group, Inc.

Natural Gas Services (NGS) is a provider of natural gas compression equipment and services to the energy industry. Natural Gas Services has a book value per share of $18.84 as of June 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $16.96 per share ($18.84 (CMT) 0.90). However, if the stock price has moved up after being added to the portfolio, you can still purchase the stock unless the price-to-book ratio goes above 1.00, which equates to a price of $18.84 per share. To calculate the maximum purchase price based on the maximum desired price-to-book ratio, multiply the current book value per share ($18.84 for Natural Gas Services) 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: Park Ohio Holdings Corp.

Park Ohio Holdings (PKOH) provides customers with a supply chain management outsourcing service, capital equipment used on production lines and manufactured components used to assemble their products. Park Ohio Holdings has a book value per share of $22.51 as of June 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $20.26 per share ($22.51 (CMT) 0.90). However, if the stock price has moved up after being added to the portfolio, you can still purchase the stock unless the price-to-book ratio goes above 1.00, which equates to a price of $22.51 per share.

Next Portfolio Review

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place around the beginning of December 2023, after most of the holdings have announced their quarterly earnings. Any changes to the portfolio will be announced at the time they are made in a special Model Shadow Stock Portfolio Update email (sign up at www.aaii.com/email).