October 2018 Model Shadow Stock Portfolio Update

The market turned bearish for small-company stocks during September with the AAII Model Shadow Stock Portfolio giving up 6.7% during the month and dropping back into negative territory for the year, with a 1.3% loss. The Vanguard Small Cap Index fund (NAESX) lost 1.5% during the month, while the DFA U.S. Micro Cap fund (DFSCX) lost 2.4% during September. The S&P 500 index, as measured through the Vanguard S&P 500 Index fund (VFINX), gained 0.6% during September and was up 10.4% for the year.

The breadth of the portfolio, which measures the general direction of the underlying stocks in the actual Model Shadow Stock tracking portfolio, turned very negative in September, reflecting the growing nervousness of the market. Of the 31 stocks that were in the portfolio at the end of September, six stocks posted gains in September compared to 24 stocks with losses; one stock ended the month unchanged. The strongest stock in the Model Shadow Stock Portfolio in September was Renewable Energy Group Inc. (REGI) which gained 6.9% during month. Renewable Energy Group finished the month at its 52-week high of $28.80. Its market cap is up to $1.015 billion and price-to-book ratio stands at 1.41.

Aceto Corp. (ACET) was the weakest holding in the Model Shadow Stock Portfolio with its 31.9% loss for September after its weak earnings announcement. Aceto’s month-end price of $2.26 is just above its 52-week low price of $2.10. Aceto has a market cap of $73.6 million and had a price-to-book ratio of 0.84. (See the news section below for earnings-related coverage of the Shadow Stock holdings.)

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.4% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.7% per year on average. Over the same period, the Vanguard Small Cap Index fund (NAESX) posted an average annual gain of 10.4%.

As of the end of September, 22 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, up from 17 at the end of August. Of these, eight are currently held in the Model Shadow Stock tracking portfolio (up from five the month before): Beazer Homes USA Inc. (BZH), CPI Aerostructures Inc. (CVU), Delta Apparel Inc. (DLA), Flexsteel Industries Inc. (FLXS), New Home Company Inc. (NWHM), Olympic Steel Inc. (ZEUS), Strattec Security Corp. (STRT) and Universal Stainless & Alloy Products (USAP). Companies held in the Model Shadow Stock Portfolio that currently meet the initial purchase rules are designated as “currently qualifies” in the notes column of the Model Shadow Stock Portfolio table on AAII.com; however, the notes will not match the list here since the webpage is constantly updated.

As of the end of September, RCM Technologies Inc. (RCMT) and Vishay Precision Group Inc. (VPG) were approaching the price-to-book-value limit of 3.0, with price-to-book-value ratios of 2.20 and 2.44, respectively. Shadow Stocks with a price-to-book-value ratio above 3.0 at the time of a quarterly review are sold from the model portfolio, assuming there is a suitable replacement.

Currently, PC Connection Inc. (CNXN) is approaching the market-cap cutoff of $1.2 billion (three times the initial limit for consideration of $400 million) with a market cap of $1.054 billion at the end of the month. Renewable Energy Group also had a market-cap above one billion at the end of the month.

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place at the end of November. 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-December AAII Model Portfolios Update email and the Model Portfolios column in the January 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.

Model Shadow Stock Portfolio News

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

• Aceto Corporation (ACET) announced financial results for the fiscal-2018 fourth quarter. Consolidated net sales for the fourth quarter were $168.9 million, a decrease of 13.2% from $194.6 million reported in the fourth quarter of fiscal 2017. Net loss was $34.7 million, or $0.98 per share, compared to net income of $2.0 million, or $0.06 per share, for the comparable quarter of fiscal 2017. Non-GAAP adjusted net loss was $17.0 million in the fourth quarter, or $0.48 per share, compared to non-GAAP adjusted net income of $9.6 million, or $0.27 per share, in the prior period. The I/B/E/S consensus earnings estimate was for a loss of $0.04 per share.
   

• Beazer Homes USA Inc. (BZH) reported that Hurricane Florence and significant flooding following the storm has impacted operations in the company’s Myrtle Beach and Charleston, South Carolina, and Raleigh, North Carolina, divisions. Beazer Homes’ CEO Allan Merrill said that the company is not aware of any “extraordinary” damage to its properties. However, while the financial impact of Hurricane Florence cannot be reasonably estimated, Beazer Homes anticipates reporting fewer home sales and home closings in the fourth quarter of 2018. Any financial impact realized is expected to be temporary, resulting from home sales and closings shifting into the first and second quarters of fiscal 2019 as the affected areas recover.
   

• Ennis Inc. (EBF) reported financial results for the second quarter of 2018. Revenue for the second quarter was $98.6 million compared to $94.9 million for the same quarter last year, an increase of 3.9%. Net earnings for the quarter were $9.6 million, or $0.37 per diluted share compared to $8.5 million, or $0.34 per diluted share, for the second quarter last year. The I/B/E/S consensus estimate for quarterly earnings was $0.35 per share, resulting in a positive surprise of 5.7%.
   
• Flexsteel Industries Inc. (FLXS) announced that Karel Czanderna has retired from her positions as president, CEO and director, effective September 9, 2018. According to Flexsteel, Czanderna’s departure was not the result of any disputes or disagreements related to the company’s operations, management or board of directors. Czanderna held her position for six years. Jeff Bertsch, a current board member and Flexsteel’s former senior vice president of corporate services, has been appointed interim president. Bertsch has been with Flexsteel for 35 years.
• RCI Hospitality Holdings (RICK) announced that a subsidiary has signed a definitive agreement to acquire all of the issued and outstanding shares of common stock of the company that owns VIP’s Gentlemen’s Club in Chicago for $6.5 million. RCI also announced a definitive agreement for a subsidiary to acquire the club’s real estate for $4.0 million. VIP’s is one of only three gentlemen’s clubs in Chicago, the only one with a full liquor license and grandfathered use. Under the terms of the agreement, consideration for the club is $2.0 million in cash and $4.5 million in seller financing.
   

• SigmaTron International (SGMA) reported financial results for the first quarter of fiscal 2019. Revenues increased 0.3% to $71.4 million compared to the same quarter in the prior year. Net income decreased to a net loss of $526,607 for the quarter ended July 31, 2018, compared to net income of $382,882 for the same period in the prior year. Basic and diluted loss per share were each $0.12, compared to basic and diluted earnings per share of $0.09 each for the same quarter ended July 31, 2017.