July Model Shadow Stock Portfolio Update

The S&P 500 index gained 18.5% during the first half of the year, its strongest start to a year since 1997. The S&P 500 as measured through the Vanguard 500 Index fund (VFINX), was up 7.0% during June. The Model Shadow Stock Portfolio was up 8.5% during June, boosting its 2019 year-to-date performance to 8.2%. The S&P MidCap 400 index was up 7.6% during June and is now up 18.0% for the year, while the Russell 2000 index gained 7.1% during the month and is up 17.0% year to date. The Vanguard Small-Cap Index fund (NAESX) was up 7.0% during the month and has a year-to-date performance of 19.4%, while the DFA U.S. Micro Cap fund (DFSCX) was up 7.3% during June and is up 12.6% for this year through the end of June.

The performance of growth versus value-oriented stocks was mixed during the month. Large-cap growth stocks were up 20.2% versus the 16.7% gain for large-cap value stocks for the first six months of the year as large-cap growth stocks were up 6.2% during June while large-cap value stocks gained 8.1% during the month.

In the mid-cap segment, value stocks are up 16.8% for the year after gaining 8.3% during June. Mid-cap growth stocks are up 19.1% for the year after gaining 7.0% during June.

Small-cap value stocks are up 13.5% year to date, while small-cap growth stocks are up 20.3%. Small-cap value stocks gained 6.4% during June, while small-cap growth stocks were up 7.7%.

Stocks in the information technology (+27.1%), consumer discretionary (+21.8%) and industrial (+21.4%) sectors are leading the market this year. Sectors that are lagging this year include pharmaceuticals (+6.1%), health care (+8.1%) and energy (+13.1%).

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 14.1% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.5% 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 10.0%.

Model Shadow Stock Portfolio Notes & News

As of the end of June, 23 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, down from 25 at the end of May. AAII members can see and research which companies are currently passing the initial selection criteria in the Shadow Stock Ideas table on AAII.com.

Of the 23 qualifying companies at the end of the month, six are currently held in the Model Shadow Stock tracking portfolio: Hallador Energy Co. (HNRG), Hooker Furniture Corp. (HOFT), Mesa Air Group (MESA), Olympic Steel Inc. (ZEUS), Universal Stainless & Alloy Products (USAP) and VSE Corp. (VSEC). 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 notes on the website table are dynamically updated daily.)

Currently, PCM Inc. (PCMI), with a price-to-book-value ratio of 2.69, is approaching the price-to-book-value ratio limit of 3.00. Shadow Stocks with a price-to-book-value ratio above 3.00 at the time of a quarterly review are sold from the model portfolio, assuming there is a suitable replacement.

PC Connection Inc. (CNXN) is approaching the market capitalization cut-off of $1.2 billion. PC Connection had a month-end market cap of $922.3 million. Shadow Stocks with a market cap above $1.2 billion at the time of a quarterly review are sold from the model portfolio, assuming there is a suitable replacement.

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.

PCM Inc. was the strongest stock in the Model Shadow Stock Portfolio with its 37.1% gain for June. PCM Inc. entered into an agreement to be acquired by Insight Enterprises Inc. (NSIT) for $35 per share for a total transaction value of $581 million. PCM Inc. is a multi-vendor provider of technology solutions, including hardware products, software and services, offered through its dedicated sales force, field and internal service teams, direct marketing channels and owned and operated data centers. PCM Inc. was added to the Model Shadow Stock Portfolio on March 2, 2010, at an average purchase price of $4.76 per share. As noted in the news section below, the acquisition is expected to close in the second half of 2019 subject to certain customary closing conditions. We will review the sale and tender options at the normal quarterly portfolio review.

Hooker Furniture was the weakest stock in the Model Shadow Stock Portfolio, dropping 23.1% during June. Hooker Furniture is a home furnishings marketing, design and logistics company offering sourcing of residential casegoods and upholstery, as well as domestically produced leather and fabric-upholstered furniture. As noted in the news section below, Hooker Furniture reported net sales for the first quarter of fiscal 2020 of $136 million, down 5% year over year. CEO Paul Toms said reduced demand and soft retail conditions across the home furnishings industry drove the year-over-year drop in sales.

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place around the end of August 2019, after most of the Shadow Stock 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).

Here are some news highlights from June for the holdings in the Model Shadow Stock Portfolio:

CPI Aerostructures Inc. (CVU) announced additional purchase orders worth a total of about $14 million from Sikorsky, a subsidiary of Lockheed Martin Corp. (LMT). CPI Aerostructures previously received purchase orders totaling approximately $8 million in October 2018 for Hover Infrared Suppression Systems (HIRSS) from Sikorsky for the Black Hawk helicopter.

Delta Apparel Inc. (DLA) announced that it was included in the preliminary list of additions to join the broad-market Russell 3000 index after market close on June 28, 2019. CEO Robert Humphreys commented, “We welcome the increased visibility the Russell indexes bring and believe it will allow us to communicate our growth story to a wider investor audience.”

Ennis Inc. (EBF) reported first-quarter 2019 revenue of $108 million, up 16% year over year. Net earnings for the quarter were $9.6 million, or $0.36 per diluted share, up 4% and 3%, respectively, year over year. Earnings per share for the quarter beat the I/B/E/S analyst consensus estimate of $0.37 per share by 10%.

CEO Keith Walters commented, “Our acquisitions continued to perform adding approximately $19.3 million to our comparable sales and $0.04 to our comparable earnings per diluted share. The paper supply has loosened because of the influx of imports due to the strengthening of the U.S. dollar, resulting in more paper pricing stability.”

Flexsteel Industries Inc. (FLXS) announced projected costs of its restructuring plans that will take place over the next two years. As a result of these planned actions, Flexsteel expects to incur pretax restructuring and related expenses of about $48 million to $53 million, of which about $36 million to $40 million will be cash and $12 million to $13 million noncash.

This range includes the $13 million of restructuring and related expenses to exit Flexsteel’s commercial office and custom-designed hospitality product lines as well as the closure of its California manufacturing facility. Flexsteel estimates that lower employee-related costs and improved efficiencies will result in an annualized, ongoing cost savings of approximately $27 million to $32 million on a run-rate basis to be achieved by the end of fiscal 2021. Additionally, the company plans to list several properties for sale, expecting to generate $45 million to $55 million in cash dependent upon market conditions at the time of the sale.

Hooker Furniture Corp. (HOFT) reported net sales for the first quarter of fiscal 2020 of $136 million, down 5% year over year. CEO Paul Toms said reduced demand and soft retail conditions across the home furnishings industry drove the year-over-year drop in sales.

Net income for the quarter was $2 million, or $0.17 per diluted share, both down 72% year over year. Earnings per share for the quarter missed the I/B/E/S analyst consensus estimate of $0.23 per share by 26%. Earnings performance was primarily driven by cost-related issues in the Home Meridian (HMI) segment and the 10% tariff on furniture and furniture components imported from China.

Looking forward, Hooker said that the company is more optimistic about the second half of the year, but current order activity is inconsistent across divisions and the residential furniture industry is experiencing deflated demand and sluggish retail conditions. The company expects the newly enacted 25% tariff on Chinese imports to cause business disruptions in the industry throughout the next several months.

PCM Inc. (PCMI) entered into an agreement to be acquired by Insight Enterprises Inc. (NSIT) for $35 per share for a total transaction value of $581 million. The transaction is subject to certain customary closing conditions, including regulatory approvals and approval of PCM Inc.’s shareholders, and is expected to close in the second half of 2019.