January 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 down 10.6% during December. By comparison, the portfolio lagged the S&P 500 large-cap index, which fell 9.0% in December when including dividends (total return). It did, however, outperform two small-company benchmarks: The Vanguard US Small Cap fund (NAESX), which lost 11.1% on a total-return basis, and the DFA U.S. Micro Cap fund (DFSCX), which saw a total-return loss of 11.8% for December.

The breadth of the portfolio, which measures the general direction of the underlying stocks in the actual Model Shadow Stock tracking portfolio, was strongly negative in December. Only two of the 31 holdings that were in the portfolio at the start of the month posted gains for the month.

December was a tough month for stocks, no matter the size or factor bias. Large-cap stocks did outperform on a relative basis, securing a second straight year where large-company stocks outpaced mid- and small-cap stocks. The large-cap S&P 500 posted a total-return loss of 9.0% in December and lost 4.4% in 2018 on a total-return basis. The S&P MidCap 400 index saw a total-return decline of 11.3% in December; for 2018, the index fell 11.1%. The S&P SmallCap 600 index fell 12.1% in December when factoring in dividends. For 2018, the small-cap index saw a total-return loss of 8.4%.

The outperformance of larger stocks is also apparent when comparing the performance of market-cap-weighted and equal-weighted indexes in 2018. The Guggenheim S&P 500 Equal Weight ETF (RSP) recorded a total-return decline of 7.8% for 2018 versus the S&P 500’s loss of 4.4%. The PowerShares Russell 1000 Equal Weight ETF (EQAL) also lagged the market-cap-weighted S&P 500 index with a total-return decline of 8.9%.

Growth tended to outperform value in December, continuing another trend from the last two years. The S&P 500 Growth index recorded a total-return decline of 8.6% in December versus a 12.4% loss, including dividends, for the S&P SmallCap 600 Value index. For 2018, the S&P 500 Growth index was the strongest style index, posting a 0.2% total-return decline versus a loss of 12.8%, 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 14.0% versus the Vanguard 500 Index fund’s (VFINX) gain of 8.9% 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 9.4%.

2018 Model Shadow Stock Portfolio Review

December’s decline pushed the Model Shadow Stock Portfolio’s 2018 cumulative decline to 24.4% after gaining 14.0% in 2017. This marked the worst annual performance for the Model Shadow Stock Portfolio since its 50.8% decline in 2008, in the midst of the financial crisis.

The table here shows the performance for the 34 stocks that were in the Model Shadow Stock tracking portfolio at any time during 2018. Eight posted positive returns while part of the Model Shadow Stock Portfolio.
 

Renewable Energy Group (REGI) was the strongest Shadow Stock of 2018, gaining 117.8%. In fact, the stock was the fourth-strongest component of the S&P 600 SmallCap index in 2018. Renewable Energy shares performed better than they did in 2017, when they rose 21.7%. The company bucked the trend of the energy sector, which ranked among the weakest for the year as it benefited from growing interest in renewable energy sources (the company is a producer of biomass-based diesel in North America). PCM Inc. (PCMI) also posted strong results for 2018, gaining 77.9%. The direct marketing company offers technology products and services.

At the other end of the performance spectrum, among the holdings of the Model Shadow Stock Portfolio is Aceto Corp. (ACET), which lost 91.7% in 2018. On April 18, 2018, Aceto announced that its 2018 fiscal-year earnings guidance should no longer be relied upon and that it anticipates recording noncash intangible asset impairment charges in the range of $230 million to $260 million.

Model Shadow Stock Portfolio Notes & News

As of the end of December, 39 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, up from 25 at the end of November. Of these, 10 are currently held in the Model Shadow Stock tracking portfolio: Beazer Homes USA Inc. (BZH), Container Store Group (TCS), CPI Aerostructures Inc. (CVU), Delta Apparel Inc. (DLA), Flexsteel Industries Inc. (FLXS), Hallador Energy Co. (HNRG), New Home Company (NWHM), Olympic Steel Inc. (ZEUS), Strattec Security Corp. (STRT) 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 valuation limit of 3.0 or the market cap cut-off of $1.2 billion.

Following its first-quarter earnings release, Aceto is on earnings probation. The company reported a quarterly loss of $0.59 per share and its trailing 12-month loss is $0.84 per share. Therefore, Aceto is on earnings probation.

Following its delayed Form 20-F filing, Amira Nature Foods Ltd. (ANFI) is on earnings probation. The company’s trailing 12-month loss is $0.09 per share.

Following its second-quarter 2019 earnings announcement, CSS Industries Inc. (CSS) is also on earnings probation. The company’s trailing 12-month loss is $0.02 per share.

If any of these companies reports an adjusted loss in its 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 December for the current holdings in the actual AAII Model Shadow Stock Portfolio:

• Ennis Inc. (EBF) reported that revenues for the third quarter were $108.1 million compared to $93.6 million for the same quarter last year, an increase of 15.5%. Net earnings for the quarter were $10.4 million, or $0.40 per diluted share compared, to $8.3 million, or $0.33 per diluted share, for the third quarter last year. Ennis beat the I/B/E/S consensus analyst earnings per share (EPS) estimate of $0.36 for the quarter by 11%.

   

• Flexsteel Industries Inc. (FLXS) announced Jerald Dittmer as the company’s new president and CEO effective December 28, 2018. Dittmer is a veteran of HNI Corp. (HNI), a publicly traded international manufacturer of office furniture.

   

• Hooker Furniture Corp. (HOFT) reported consolidated net sales of $171.5 million and net income of $9.3 million, or $0.79 per diluted share, for its fiscal-2019 third quarter ended October 28, 2018. Net sales increased 8.6%, or $13.5 million, from the comparable prior-year quarter, and net income increased 29.6%, or $2.1 million. Earnings per diluted share increased 29.5% from $0.61 a year ago. Hooker Furniture’s diluted earnings per share of $0.79 beat the I/B/E/S consensus analyst earnings estimate of $0.75 for the quarter by 5%.

   

• PC Connection Inc. (CNXN) announced a new share repurchase program authorizing up to $25 million in share repurchases with no fixed termination date. The company said it would exhaust the remaining $6.1 million of its previous repurchase program before beginning its new one.

   

• RCI Hospitality Holdings Inc. (RICK) reported a loss of $0.27 per share for the fourth quarter of 2018, compared to a loss of $0.23 per share in the fourth quarter of 2017. Total revenues of $40.7 million increased 3.7%; growth reflected a 2.1% increase in consolidated same-store sales and contributions from new units. Non-GAAP diluted earnings per share for the quarter were $0.41, which missed the I/B/E/S consensus analyst earnings estimate of $0.465 per share for the quarter by about 12%.

   

• Renewable Energy Group (REGI) named Cynthia Warner to the position of president and CEO effective January 14, 2019, at which time she will also join the board of directors. Randy Howard, who has served as president and CEO since July 2017, will remain on the board and assist in the transition. Warner most recently served as executive vice president of operations for Andeavor (formerly Tesoro Corp.), an integrated marketing, logistics and refining company now owned by Marathon Petroleum Corp. (MPC).