February 2019 Model Shadow Stock Portfolio Update

There are no changes this month to the Model Shadow Stock Portfolio.

The Model Shadow Stock Portfolio, which is a real-money portfolio of micro-cap value stocks, was up 15.9% during January. By comparison, the portfolio outperformed the S&P 500 large-cap index, which rose 8.0% in January when including dividends (total return). It also outperformed two small-company benchmarks: The Vanguard Small-Cap Index fund (NAESX), which gained 11.8% on a total-return basis, and the DFA U.S. Micro Cap fund (DFSCX), which saw a total-return gain of 10.1% during January.

With the strong start to the year, investors are hopeful that the old Wall Street adage “As January goes, so goes the year” will hold true this year.

Based only on past data, a positive stock market gain during January has been generally bullish for the market. Research at CFRA notes that since World War II, the market ended the year higher 83% of the time.

One must consider that January’s performance is one-twelfth of the performance for the year. Nevertheless, a strong January performance normally coincides with strong performance for February through December. In the 14 years during which the S&P 500 gained 5% or more during January, the index showed gains in the following months 11 times and finished the year in the black 12 out of 14 times. Table 1 notes the years since WWII that had gains of 5% or more.

The strongest January observed since WWII was in 1987 when the market gained 13.2%, only to lose 11.1% in the following months of the year; however, for the year overall, 1987 finished in the black with a gain of 2.0%.

Last year, the market gained 5.6% during January but lost 11.2% from February through December, ending the year with a 6.2% loss for all of 2018. The gain in January of 2018 was a continuation of the market run of 2017, fueled by optimism about the tax bill benefit and strong global growth.

In contrast, this year’s gain is a strong snapback from the market weakness that hit bottom on December 24, 2018. The market was driven down last year as investors grew worried over the prospect of slower global economic growth, unsettled trade conflict between the U.S. and China, weakness in oil prices, a pending partial government shutdown and the uncertainty regarding future Federal Reserve tightening. Once the Federal Reserve started to signal that it was responsive to economic data and would take a more dovish wait-and-see approach to the future interest rate increases, the market found its footing and moved to the upside.

The strength of the market gains during January can be seen in the breadth of the gains in the portfolio. During December, only two stocks in the Model Shadow Stock Portfolio showed gains. During January, all but two Shadow Stocks were up for the month.

Stocks of smaller firms outperformed those of larger firms on a relative basis during January. The large-cap S&P 500 posted a total-return gain of 8.0% in January. The S&P MidCap 400 index saw a total return of 10.5% in January, while the S&P SmallCap 600 index was up 10.6% in January when factoring in dividends.

The outperformance of smaller stocks is also apparent when comparing the performance of market-cap-weighted and equal-weighted indexes during January. The Invesco S&P 500 Equal Weight ETF (RSP) recorded a total-return gain of 15.8% for the month versus the S&P 500’s gain of 8.0%. The PowerShares Russell 1000 Equal Weight ETF (EQAL) also outperformed the market-cap-weighted S&P 500 index with a total return of 10.6% during January.

Value tended to outperform growth in January, reversing a trend from the last two years. The S&P 500 Growth index recorded a total return of 7.5% in January versus a 8.6%, including dividends, for the S&P SmallCap 600 Value index.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 14.6% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.2% per year on average over the same period. Over the same period, the Vanguard Small Cap Index fund (NAESX) posted an average annual gain of 9.9%.

Model Shadow Stock Portfolio Notes & News

As of the end of January, 21 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, down from 39 at the end of December. Of these, seven are currently held in the Model Shadow Stock tracking portfolio: Beazer Homes USA Inc. (BZH), CPI Aerostructures Inc. (CVU), Flexsteel Industries Inc. (FLXS), Hallador Energy Co. (HNRG), New Home Company Inc. (NWHM), Olympic Steel Inc. (ZEUS) and Universal Stainless & Alloy Products (USAP). Qualifying companies are those held in the Model Shadow Stock Portfolio that currently meet the initial purchase rules. (They are designated as “qualifies” in the notes column of the Model Shadow Stock Portfolio table on AAII.com. However, the notes may not match the list here since the passing list on the website is revised daily and the notes are dynamically updated based on the revised list.)

Currently, none of the holdings in the Model Shadow Stock Portfolio are approaching the price-to-book-value ratio limit of 3.0. Renewable Energy Group Inc. (REGI) however is approaching the market cap cut-off of $1.2 billion with its month-end market capitalization of $1.052.6 billion.

Aceto Corp. (ACET), Amira Nature Foods Ltd. (ANFI), CSS Industries Inc. (CSS) and Seneca Foods Corp. (SENEA) are on earnings probation. If any of these companies report an adjusted loss in their next period, they will be removed from the portfolio. However, if any company reports positive adjusted earnings next period, even if trailing adjusted earnings remain negative, the company would not meet the earnings sell rule.

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place in late February. Any changes to the portfolio will be announced at the time they are made in a special Model Portfolios Update email (sign up at www.aaii.com/email), as well as highlighted in the mid-March AAII Model Portfolios Update email and in the Model Portfolios column in the April 2019 issue of the AAII Journal.

Click here to see the current purchase and sell rules for the portfolio. The size and value rules are subject to revision depending on prevailing market conditions.

Here are some news highlights from January for the current holdings in the actual AAII Model Shadow Stock Portfolio:

• Big 5 Sporting Goods Corp. (BGFV) reported sales of $247.1 million for the fourth quarter of 2018, up 1.7% year over year from sales of $242.9 million. Same-store sales increased by 1.1%, but merchandise margins decreased about 11%.
  
  Based on reported sales results, Big 5 Sporting Goods revised its earnings guidance for the quarter. They now expect a loss per share in the range of $0.15 to $0.17, which compares to the previous guidance range for a loss per share in the range of $0.15 to $0.25. For the full year, the company expects a loss per share in the range of $0.08 to $0.10.
   
• Delta Apparel Inc. (DLA) announced anticipated first-quarter 2019 sales of $101 million, up about 12% year over year from $90.3 million in first-quarter 2018. Based on these sales results, Delta Apparel expects earnings per share (EPS) for the first quarter of 2019 to be above that of first-quarter 2018, with adjusted earnings per share in line with first-quarter 2018’s adjusted earnings per share of $0.08. CEO Robert Humphreys said the company was pleased with its start to the new fiscal year and the broad-based momentum they are seeing across their business segments.
   
• RCI Hospitality Holdings (RICK) reported sales of $43.4 million for the first quarter of 2019, up 6.5% year over year, with same-store sales up 0.7% to $40 million. CEO Eric Langan said, “fiscal 2019 has started off well in what is seasonally our strongest period with record first-quarter club and restaurant sales, featuring solid same-store growth in nightclubs and good performance across the board from new clubs and new Bombshells locations.”
  
  RCI Hospitality also announced authorization to repurchase an additional $10 million in common stock, bringing total available funds for repurchase to $12.7 million. Langan said, “our capital allocation strategy indicates repurchasing shares in the open market when the yield on our free-cash-flow run rate relative to our market capitalization meets or exceeds double digits. At a current free-cash-flow run rate of $26 million that signals buying shares at $27 or less, unless there is a significant strategic rationale to do otherwise.”
   
• Strattec Security Corp. (STRT) reported sales for the second quarter ended December 30, 2018, of $112.9 million, up about 9% from sales of $103.2 million in the same period one year ago. Net loss for the current-year quarter was $22.2 million, compared to net income of $2.9 million in the prior-year quarter. Diluted loss per share for the current-year quarter was $5.96 compared to diluted earnings per share of $0.78 in the prior-year quarter.
  
  During the current-year quarter, Strattec completed a substantial portion of terminating the Strattec Pension Plan that was frozen in December 2009. A noncash pretax pension settlement charge of $32.4 million was recorded during the current-year quarter. A remaining noncash compensation expense charge of approximately $8 million on a pretax basis is expected to be recorded in future periods when the plan is fully terminated and the excess plan assets are transferred to a Strattec defined contribution plan and subsequently paid out.
   
• Townsquare Media Inc. (TSQ) announced the departure of co-founder and co-CEO, Dhruv Prasad, who resigned effective immediately January 31. Prasad co-founded Townsquare in 2010 and served as senior vice president of strategy and operations and executive vice president of live events before being appointed co-CEO in 2017. Bill Wilson will transition from co-CEO to serve as the sole CEO of the company.
   
• Universal Stainless & Alloy Products (USAP) reported that net sales for the fourth quarter of 2018 were $57.1 million, an increase of 13.5% from $50.3 million in the fourth quarter of 2017. All end markets contributed to the year-over-year growth, with the exception of power generation and general industrial. Aerospace remained the company’s largest end market, at 61.5% of total company sales, up 23.7% from the fourth quarter of 2017.
  
  Net income for the fourth quarter of 2018 totaled $0.6 million, or $0.07 per diluted share, compared with net income of $7.9 million, or $1.06 per diluted share, in the fourth quarter of 2017, which included a net tax benefit of $1.06 per diluted share primarily attributable to the new federal tax legislation. Before the tax benefit, net income in the fourth quarter of 2017 was breakeven.