Performance of the Model Shadow Stock Portfolio has firmed a bit this past quarter, but year to date it still lags the S&P 500 index as measured by the Vanguard 500 Index fund 
(VFINX).
The Model Shadow Stock Portfolio has returned 1.2% year to date as of May 31, while the Vanguard 500 Index fund gained 3.2% over the same period. These and longer-term results can be seen in Figure 1 and Table 3.
In general, small stocks are doing better but value stocks are still lagging the market. Overall, the stock market’s performance is below average for the first five months of 2015. This year certainly does not look like the typical pre-election year, but we do have seven months to go.
Major Rule Change
Over the years, the number of qualifying stocks we encounter in each period has varied considerably. We have had times with zero qualifiers, and in 2008 we reached almost 100 qualifiers. Beyond this volatility, I believe there has been a fundamental shift that will provide fewer qualifying stocks on average under the current rules. This shift may be due to more awareness of the superiority of micro-cap stocks, or it might be a side effect of the larger market value of all stocks.
Our current market capitalization requirement of less than $300 million for purchase puts our stocks in the lowest decile (10%) for market cap as generally measured. While both of the lowest two deciles are considered micro-cap stocks, I believe we should stick with the current requirement because smaller size at this level appears to make more of a difference in results than changes in value (measured by price-to-book-value ratio). In addition, with a maximum of three times the initial criterion, we let stocks run well into the seventh decile for market cap before we sell them.
While the price-to-book ratio is very important, we are at a very low level (a high level of value) compared to most measures of value. In the June 2015 AAII Journal, Charles Rotblut discussed the role of value and its measurement quite extensively (“Using Book Value to Judge a Stock’s Worth”). Most research bases the choice of low or high value on where in the population of price-to-book ratios a stock lies. Is it in the lower half, the lower third, the lower quarter? Based on that, our current rules of a maximum level of 0.80 for purchase would initially put our stocks in approximately the lowest 10%.
The average price-to-book ratio has been increasing in recent years. Based on that, and because I feel comfortable with the notion of stocks selling at book value or less as being bargains per se, I am raising the initial criterion for the price-to-book ratio limit to 1.00. This also means we will not sell a stock because of price-to-book ratio until it exceeds 3.00 (three times the initial criterion), which many analysts would still consider a value stock. This will give us more stocks to choose from and still keep us close to the lower 10% for both market-cap size and price-to-book ratio.
There is one further change having to do with the approach to choosing from among qualifying stocks when the portfolio does not have sufficient funds to buy them all. Since differences between stocks do not seem to be too significant in our range of price-to-book ratio, we will emphasize the transaction costs. Transaction costs are impacted by the width of the bid/ask spread—much narrower being better—but the number of shares at the bid or ask is also important because the spread can widen quickly with large orders. So the lowest transaction cost can be different for different-sized portfolios.
Finally, we will give preference to U.S. stocks. We do this to avoid being in the currency-predicting business. We will continue to buy foreign stocks (except for those based in China), if they are listed on a U.S. exchange and if they otherwise qualify. But, as with illiquid stocks, they will be the last choices.
The box here details the current purchase, sale and management rules as well as stock order guidance for the Model Shadow Stock Portfolio.
Table 1. The Model Shadow Stock Portfolio
|
|
Current Price ($) |
52-Week |
Market Cap ($ Mil) |
P/E Ratio (X) |
P/B Ratio (X) |
Div Yield (%) |
Notes |
|
|
|
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| Company (Ticker) |
High ($) |
Low ($) |
||||||
| Alamo Group, Inc. (ALG) | 52.97 | 64.45 | 37.93 | 603.1 | 15.2 | 1.8 | 0.6 | |
| CDI Corp. (CDI)* | 12.37 | 19.24 | 11.93 | 243.0 | 154.6 | 0.91 | 4.2 | |
| CSS Industries Inc (CSS) | 27.59 | 33.00 | 23.11 | 257.8 | 15.3 | 0.95 | 2.6 | |
| Ducommun Incorporated (DCO) | 23.29 | 33.45 | 22.60 | 257.5 | 20.6 | 1 | 0.0 | |
| Ennis, Inc. (EBF) | 16.82 | 17.21 | 12.51 | 434.1 | nmf | 1.52 | 4.2 | |
| Flexsteel Industries (FLXS) | 37.77 | 38.43 | 28.56 | 281.0 | 13.0 | 1.55 | 1.9 | |
| Global Power Equip (GLPW) | 7.48 | 17.68 | 7.42 | 128.4 | 11.5 | 0.45 | 4.8 | |
| Hardinge Inc. (HDNG) | 10.70 | 13.29 | 9.70 | 137.5 | nmf | 0.81 | 0.7 | |
| Hooker Furniture Corp. (HOFT) | 25.27 | 27.30 | 13.66 | 273.2 | 21.8 | 1.9 | 1.6 | |
| Key Tronic Corp. (KTCC) | 11.41 | 12.49 | 7.50 | 120.4 | 42.3 | 1.21 | 0.0 | |
| Kimball Electronics (KE) | 15.58 | 16.13 | 5.19 | 454.5 | 18.8 | 1.5 | 0.0 | |
| L S Starrett Co. (SCX) | 18.11 | 21.95 | 12.62 | 126.6 | 14.4 | 1.06 | 2.2 | |
| LMI Aerospace, Inc. (LMIA) | 9.96 | 15.39 | 9.90 | 131.3 | nmf | 1.08 | 0.0 | |
| Marlin Business Services (MRLN) | 17.87 | 21.75 | 15.97 | 229.2 | 12.3 | 1.27 | 2.8 | |
| Olympic Steel, Inc. (ZEUS) | 17.54 | 25.83 | 10.44 | 192.9 | nmf | 0.7 | 0.5 | |
| PC Connection, Inc. (PCCC) | 24.92 | 29.50 | 19.26 | 656.7 | 15.0 | 1.81 | 0.0 | |
| PCM Inc. (PCMI) | 9.69 | 11.82 | 7.43 | 116.8 | 484.5 | 0.92 | 0.0 | |
| RCM Technologies, Inc. (RCMT) | 5.66 | 7.33 | 4.61 | 71.9 | 10.3 | 1.64 | 0.0 | |
| Renewable Energy Group (REGI) | 10.63 | 12.30 | 8.10 | 467.0 | 9.4 | 0.65 | 0.0 | |
| REX American Resources (REX) | 63.87 | 110.65 | 51.63 | 502.7 | 7.4 | 1.43 | 0.0 | |
| Rocky Brands Inc. (RCKY) | 19.17 | 23.11 | 12.61 | 145.0 | 13.7 | 1.04 | 2.3 | |
| Salem Communications (SALM) | 4.70 | 11.00 | 4.38 | 119.5 | 22.4 | 0.59 | 5.5 | qualified as of 05/31/2015 |
| Shoe Carnival, Inc. (SCVL) | 27.64 | 29.79 | 16.68 | 566.1 | 20.5 | 1.59 | 0.9 | |
| SigmaTron International (SGMA) | 8.60 | 12.44 | 5.55 | 34.9 | 30.7 | 0.62 | 0.0 | qualified as of 05/31/2015 |
| TravelCenters of America (TA) | 15.74 | 18.10 | 7.92 | 603.5 | 7.8 | 1.07 | 0.0 | |
|
Ultra Clean Holdings (UCTT)* |
6.47 | 10.29 | 5.26 | 204.6 | 35.9 | 0.96 | 0.0 | |
| Universal Stainless & Alloy (USAP) | 18.05 | 34.22 | 17.76 | 128.0 | 27.8 | 0.62 | 0.0 | qualified as of 05/31/2015 |
|
Vishay Precision Group (VPG)* |
13.20 | 17.95 | 12.74 | 165.0 | 66.0 | 0.92 | 0.0 | |
| VOXX International (VOXX) | 8.55 | 11.55 | 6.56 | 206.6 | nmf | 0.52 | 0.0 | |
| Willis Lease Finance (WLFC) | 18.30 | 26.19 | 17.89 | 151.2 | 27.3 | 0.66 | 0.0 | qualified as of 05/31/2015 |
|
* Added to portfolio 6/4/2015. nmf = no meaningful figure Source: AAII’s Stock Investor Pro/Thomson Reuters. Data as of 5/31/2015. |
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Explanation of Notes
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 $300 million. Stocks are marked “approaching size limit” if their current market cap exceeds 2½ times the initial criterion, or $750 million.
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 1.00. Stocks are marked “approaching value limit” if their current price-to-book-value ratio exceeds 2½ times the initial criterion, or 2.50.
Earnings Probation: If the last 12 months’ earnings from continuing operations 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. The date in parentheses is the fiscal quarter during which the company first reported negative trailing 12-month earnings.
Qualified 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.
See the Model Shadow Stock Portfolio area of AAII.com for more information.
Portfolio Changes
The portfolio changes this quarter are based on the new rules. The current holdings can be seen in Table 1 and the changes in Table 2.
Four stocks were sold:
- Five Star Quality Care (FVE) violated the earnings rule,
- International Shipholding (ISH) violated the earnings rule,
- Kimball International (KBAL) exceeded even the new price-to-book limit of 3.0 and
-
Mitcham Industries (MIND) violated the earnings rule.
Proceeds were used to buy positions in three new stocks:
Table 2 indicates the maximum price to pay to stay at or below the new price-to-book limit of 1.00 for these new purchases.
We had some funds left over and bought some additional shares of Salem Communications (SALM) because it currently qualifies and was underweighted in the portfolio.
Table 2. Second-Quarter 2015 Transactions
| Sell | |
| Company (Ticker) | Reason |
| Five Star Quality Care, Inc. (FVE) | violated earnings probation |
| International Shipholding Corp (ISH) | violated earnings probation |
| Kimball International Inc. (KBAL) | exceeded value limit |
|
Mitcham Industries, Inc. (MIND) |
violated earnings probation |
| Buy | |
| Company (Ticker) | Maximum Price to Pay |
| CDI Corp. (CDI) | $13.59 |
|
Ultra Clean Holdings, Inc. (UCTT) |
$6.74 |
|
Vishay Precision Group (VPG) |
$14.35 |
| Purchased Additional Shares With Excess Cash | |
| Salem Media Group Inc. (SALM) | |
Table 3. Model Shadow Stock Portfolio: Annual Performance
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|
Average Annual Return (%) | Cumulative Value of $10,000 ($) | ||||
|
|
Model Shadow Stock Portfolio |
Vanguard 500 Index (VFINX) |
Vanguard Small Cap Index (NAESX) |
Model Shadow Stock Portfolio |
Vanguard 500 Index (VFINX) |
Vanguard Small Cap Index (NAESX) |
|
|
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|
|
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| Year | ||||||
| 1993 | 32.3 | 9.9 | 18.7 | 13,230 | 10,989 | 11,870 |
| 1994 | 2.0 | 1.2 | -0.5 | 13,492 | 11,118 | 11,810 |
| 1995 | 20.7 | 37.4 | 28.7 | 16,291 | 15,282 | 15,204 |
| 1996 | 22.3 | 22.9 | 18.1 | 19,927 | 18,775 | 17,959 |
| 1997 | 44.3 | 33.2 | 24.6 | 28,756 | 25,010 | 22,375 |
| 1998 | -8.9 | 28.6 | -2.6 | 26,188 | 32,168 | 21,790 |
| 1999 | 0.0 | 21.1 | 23.1 | 26,187 | 38,945 | 26,831 |
| 2000 | -7.7 | -9.1 | -2.7 | 24,163 | 35,418 | 26,116 |
| 2001 | 21.4 | -12.0 | 3.1 | 29,325 | 31,160 | 26,926 |
| 2002 | 10.8 | -22.1 | -20.0 | 32,506 | 24,259 | 21,535 |
| 2003 | 73.1 | 28.5 | 45.6 | 56,268 | 31,174 | 31,360 |
| 2004 | 43.7 | 10.8 | 19.9 | 80,843 | 34,530 | 37,587 |
| 2005 | 17.9 | 4.8 | 7.4 | 95,353 | 36,180 | 40,376 |
| 2006 | 29.4 | 15.6 | 15.6 | 123,363 | 41,832 | 46,687 |
| 2007 | -1.8 | 5.4 | 1.2 | 121,166 | 44,083 | 47,227 |
| 2008 | -50.8 | -37.0 | -36.0 | 59,582 | 27,764 | 30,217 |
| 2009 | 72.3 | 26.5 | 36.1 | 102,665 | 35,120 | 41,130 |
| 2010 | 45.4 | 14.9 | 27.7 | 149,238 | 40,358 | 52,529 |
| 2011 | 6.3 | 2.0 | -2.8 | 158,701 | 41,155 | 51,067 |
| 2012 | 33.3 | 15.8 | 18.0 | 211,588 | 47,666 | 60,274 |
| 2013 | 61.0 | 32.2 | 37.6 | 340,599 | 63,009 | 82,966 |
| 2014 | -5.8 | 13.5 | 7.4 | 320,844 | 71,516 | 89,105 |
| YTD | 1.2 | 3.2 | 5.0 | 324,694 | 73,804 | 93,560 |
| Since Incep | 16.7 | 9.3 | 10.3 | 324,694 | 73,804 | 93,560 |
|
Data as of 5/31/2015. |
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Looking Ahead
The stock market continues to stay in a holding pattern close to all-time highs. One gets the feeling that it is ready to move dramatically one way or the other, and analysts seem split in their opinion of which direction it will take. There have been two unexpected major influences: a dramatic drop in oil prices and a quick, extensive rise in the dollar. The various impacts of these occurrences are hard to sort out.
I thought we would see the Federal Reserve enable a small rise in interest rates by fall or maybe even the summer if the employment picture continued to improve. However the International Monetary Fund (IMF) is asking the Fed to postpone interest rate hikes until 2016.
I have the feeling that the next three months will be dramatic, but I am not sure in what way.
The next article on the Model Shadow Stock Portfolio will be in the October issue of the AAII Journal. In the meantime you can follow the portfolio here.
Model Shadow Stock Portfolio Rules
Purchase and Sales Rules
Stock purchases must meet these criteria:
- No bulletin board or pink sheet stocks will be purchased.
- Price-to-book-value ratio must be less than or equal to 1.00. (Figure will change gradually with changes in overall market values.)
- Market capitalization must be between $30 million and $300 million. (Figure will change gradually with changes in overall market values.)
- The firm’s last quarter and last 12 months’ earnings from continuing operations must be positive and, if there are earnings estimates, the estimates must be positive for the current quarter and year.
- No financial stocks or limited partnerships will be purchased.
- No stocks on foreign exchanges or ADRs will be purchased because of different accounting and/or withholding tax on dividends. Foreign stocks traded primarily on U.S. exchanges are OK with one exception: The stock of any company whose primary business is in China will not be purchased.
- The share price must be greater than $4.
- In order to reduce trading by avoiding stocks that are forever marginal, any stock that was sold within two years will not be rebought.
- Note second item under Stock Order Guidance concerning spreads when buying shares.
- Price-to-sales ratio must be less than 1.2. (Figure may change gradually with changes in overall market values.)
- Eliminate any company that failed to file a 10-Q (quarterly) report in the last six months.
Stocks are sold if any of the following occur:
- If last 12 months’ earnings from continuing operations are negative, the stock is put on probation; if a subsequent quarter has negative earnings prior to 12-month earnings from continuing operations becoming positive, the stock is sold.
- The stock’s price-to-book-value ratio goes above three times the initial criterion and there is a stock to replace it.
- Market capitalization goes above three times the initial maximum criterion and there is a stock to replace it.
Stock Order Guidance
- These rules are for general guidance. Your own experience, market conditions and the size of the position will impact your own decisions. The results in the model portfolio were obtained while sometimes paying more.
- Market orders are not used. Instead, if the quoted bid-ask spread is less than 2% (ask price minus bid price, divided by ask price), place a limit order at the ask price for a buy and at the bid price for a sell. If the bid-ask spread is more than 2%, try to place a limit order between the bid and ask prices to keep transaction costs low. If necessary, build a position gradually. With low commissions, it is often better to place partial orders than to try to establish a large position all at once. Be patient.
- The average daily dollar volume should be at least four times the amount needed for your position. This will ensure liquidity to get in and out of the position, even if you need to grow the position gradually and sell gradually. This will result in a varying number of qualifying stocks for each investor.
- If price changes cause a stock to become ineligible (due to changes in price-to-book-value ratio or market capitalization) when only part of the order has been filled, stocks already purchased are kept but the balance of the order is canceled.
Management Rules
- Equal dollar amounts are invested in each stock initially.
- Decisions are made only at the end of each quarter. In order to react to the majority of earnings reports as soon as possible, quarterly reviews are made in February, May, August, and November.
- Best judgment is used for tenders or mergers, but all criteria must be obeyed.
- At the end of a quarter, if receipts from stocks sold exceed requirements for new purchases, the excess receipts—up to 5% of the portfolio’s value—are kept in cash until the next quarter. If the excess receipts are greater than 5% of the total portfolio value, the amount above 5% is distributed to smaller holdings that still qualify as buys. Efficient quantities are purchased: If over 10% of the portfolio is in cash, the price-to-book-value ratio can be moved up, but never over 1.00.
- At the end of a quarter, if receipts from stock sales are insufficient to buy all newly qualifying stocks, purchases are made based on the width of the bid-ask spread and the number of shares at bid or ask price.
- Note that if you are managing your own portfolio, it should consist of at least 10 stocks. If you are developing the portfolio gradually, you can do it stock by stock, but don’t put more than 10% of your funds in each additional stock. More than 20 stocks is not needed until the portfolio exceeds $1 million.
Discussion
FREE REPORT
VIRGINIA WILLIS from KENTUCKY posted over 11 years ago:
Rob Joslyn from WA posted over 11 years ago:
Charles Rotblut from IL posted over 11 years ago:
Ryan from GA posted over 11 years ago:
Charles Rotblut from IL posted over 11 years ago:
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