January Model Shadow Stock Portfolio Update

The Model Shadow Stock Portfolio finished the year on a positive note, gaining 11.2% in December, which helped to lift the portfolio’s gain to 13.8% for the year. The annual gain is just below the long-term compound annual return of 14.2% of the Model Shadow Stock Portfolio. The 13.8% gain also does not capture the market gyrations that investors felt during the year.

The longest bull market on record was followed by the shortest bear market in history—33 days. The Model Shadow Stock Portfolio experienced a 48.5% loss in the first quarter of 2020, and then gained 120.7% from April through December to result in its 13.8% annual return. It takes a 100% gain (doubling) to win back a 50% loss.

The 13.8% annual gain for the Model Shadow Stock Portfolio fell short of the 18.3% return realized by the large-cap Vanguard 500 Index fund (VFINX) during 2020.

There was a greater-than-normal divergence in sector performance during 2020. Companies that thrived during the pandemic recorded strong gains, while economically sensitive industries such as energy, airlines and retail real estate suffered.

Information technology led the market again during 2020 gaining 43.9% after a stellar gain of 50.3% during 2019. Other sector leaders during 2020 include consumer discretionary (+33.3%) and communication services (+23.6%). Energy ended the year with gain, up 27.8% during the fourth quarter, but was down 33.7% for the year. It was also the weakest-performing sector during 2019 with a gain of 11.8%. Other weak sectors during 2020 include real estate (–2.2%) and financials (–1.8%). Low interest rates hurt financials.

The performance of growth-oriented versus value-oriented stocks favored growth stocks by a large margin during 2020 and large-cap stocks outperformed small-cap stocks during the year.

In the large-cap segment, growth stocks were up 4.1% for the month, giving them a positive 33.5% gain during 2020. Large-cap value stocks were up 3.5% during December, putting them into positive territory with a 1.4% gain for 2020.

In the mid-cap segment, growth stocks were up 22.8% for the year, after gaining 6.4% during December. Mid-cap value stocks were up 3.7% for 2020, after gaining 6.6% during December.

Small-cap growth stocks were up 19.6% during 2020, after gaining 8.9% during the December. Small-cap value stocks were up 2.5% during 2020 after gaining 7.6% during December.

Small-cap companies tend to be more sensitive to economic conditions, and investors rotated into economically sensitive stocks as positive results of coronavirus vaccine trials surfaced during November.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 14.2% versus the Vanguard 500 Index fund’s gain of 10.0% per year on average over the same period, and the Vanguard Small Cap Index’s (NAESX) average annual gain of 10.3%.

Holding Period Performance

Even with a gain of 13.8% for the year, the Model Shadow Stock Portfolio underperformed the Vanguard 500 Index fund, which gained 18.3% last year. The Model Shadow Stock Portfolio has now underperformed the Vanguard 500 Index fund over the last four calendar years but has a stronger longer-term record. This type of pattern is consistent with historical observations of the relative performance of small-company stocks to that of large-company stocks. Small-company stocks have outperformed large-company stocks over the long term, but they certainly do not best large-cap stocks every year, and they tend to exhibit streaks of outperformance followed by periods underperformance.

Over its 28-year existence, the Model Shadow Stock Portfolio outperformed the Vanguard 500 Index fund in 16 of the 28 calendar years or 57% of the years.

Since calendar years are somewhat arbitrary start and end dates, rolling periods are often used to smooth out seasonality. There have been 3,325 rolling 12-month time periods over the last 28 years. The Model Shadow Stock Portfolio has outperformed the Vanguard 500 Index fund in 57% of the one-year periods. When it comes to three-year holding periods, the Model Shadow Stock Portfolio has outperformed the Vanguard 500 Index fund in 54% of the periods, while outperforming the Vanguard 500 Index fund in 71% of the five-year rolling periods and in 93% of the rolling 10-year periods over last 28 years.
 

It is important to consider that a historical pattern may not repeat itself in the future, but longer holding periods normally provide a greater likelihood that stocks exhibit their potential for positive returns. A very practical way to view investor risk is to examine the likelihood that your invested money will diminish from the time of the initial investment to the end of the holding period time frame and to keep in mind that the variability of expected annual return is reduced with longer holding periods.

The table above assumes an investment in the Model Shadow Stock Portfolio or the Vanguard 500 Index fund and remains invested for the holding period indicated; the table indicates the percentage of times the portfolio would have suffered a loss from 1993 through 2020. The table also notes the greatest compound annual gain and loss observed for the various holding periods.

The table helps to reinforce the important lesson that the impact of the large variability in short-term stock market returns is reduced with longer holding periods. The Model Shadow Stock Portfolio gained as much as 105.9% during one 12-month holding period, but it has also lost more than half its value during a 12-month holding period. Stocks offer the potential for greater returns over the long term compared to safer holdings such as T-bills, but you must have a longer time horizon to help realize the potential. The variability of returns—risk as measured by the chance of loss—goes down as the holding period gets longer.

Model Shadow Stock Portfolio Update

Twelve stocks met the initial selection criteria for the Model Shadow Stock Portfolio as of January 8, 2021, down from 14 passing stocks one month ago. Without the increase in the price-to-book maximum, seven stocks would have passed the initial filter. AAII members can see and research which companies are currently passing the initial selection criteria in the Shadow Stock Ideas table on AAII.com. The list of Shadow Stock Ideas is updated daily—Tuesday through Saturday.

Of the 12 qualifying companies, three are currently held in the Model Shadow Stock tracking portfolio: Global Ship Lease Inc. (GSL), Key Tronic Corp. (KTCC) and Mesa Air Group (MESA). Qualifying companies are those held in the Model Shadow Stock Portfolio that currently meet the initial purchase rules. (They are designated as “currently qualifies” in the notes column of the Model Shadow Stock Portfolio table on AAII.com. However, if you go online, the notes may not match the list discussed here since the notes on the website table are dynamically updated daily.)

As of January 8, 2021, Hibbett Sports Inc. (HIBB) had the highest price-to-book-value ratio in the Model Shadow Stock Portfolio. Its ratio of 2.37 is above the 1.00 maximum value used for initially qualifying a stock for inclusion to the portfolio. However, stocks are not removed from the portfolio until their price-to-book-value ratio rises to three times the initial maximum value (3.00).

As we have noted, it may help you to think about values below 1.00 as being very attractive, while values three times above the initial maximum are expensive. Allowing the price-to-book ratio to expand for stocks that you own allows your winners to run up in value, since the price-to-book ratio typically gets larger as the stock price goes up. The initial price-to-book level is adjusted over time to reflect the changing market conditions, and valuation and size requirements are being examined for the next quarterly portfolio review.

The Model Shadow Stock Portfolio looks for stocks with a market capitalization (share price times shares outstanding) greater than $30 million but less than $300 million when adding stocks to the portfolio. Shadow stocks with a market cap three times the initial market cap maximum ($300 million × 3 = $900 million) at the time of a quarterly review are removed from the portfolio, assuming there is a suitable replacement. Hibbett Sports also has the highest market cap in the portfolio, with a value of $860.3 million as of January 8, 2021.

Click here to see the current purchase and sell rules for the portfolio.

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place around the beginning of March 2021, after most of the 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).

Model Shadow Stock Portfolio News

Perion Network Ltd. (PERI) was the top-performing stock in the Model Shadow Stock Portfolio for December, up 67.7%. The stock was up on news during the month of the company raising its financial guidance for the fourth quarter of 2020, showing sequential quarterly improvement as sectors of the economy recover from the impact of the coronavirus pandemic.

Hallador Energy Co. (HNRG) was the second-best-performing stock with a gain of 48.5% during December. The stock saw positive price movement and a surge in trading with the passing of the federal government’s pandemic stimulus package before the end of the year.

Covenant Logistics Group Inc. (CVLG) was the worst-performing stock in the portfolio for December, down by 19.9%. There was no company-specific news during the month to indicate a reason for the stock’s downward trend. Covenant Logistics’ last major news item was its third-quarter earnings report that beat analyst expectations at the end of October.

New Home Company Inc. (NWHM) followed as the second-worst-performing stock with a loss of 16.5% during the month. There was no company-specific news during the month to indicate a reason for the stock’s downward trend. New Home Company’s last major news item was its announcement of a new stock repurchase program in November.

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

Bassett Furniture Industries Inc. (BSET) declared a special dividend of $0.25 per share, up 56.3% from its previous declaration. The dividend was payable on December 22, 2020, to shareholders of record as of December 14, 2020.

Container Store Group Inc. (TCS) announced that CEO Melissa Reiff will retire on March 1, 2021, and that Satish Malhotra will take over the CEO role on February 1, 2021. Malhotra most recently served as the chief retail and operating officer for Sephora.

CPI Aerostructures Inc. (CVU) reported that third-quarter 2020 revenue increased by 12.7% to $25.6 million year over year and surged 29.6% sequentially. Earnings per diluted share for the quarter were $0.07, compared to a loss per diluted share of $0.11 in the third quarter of 2019. Earnings per share for the quarter beat the I/B/E/S consensus estimate of $0.02 per share.

Revenue growth was primarily driven by CPI Aerostructures’ production ramp-up on newer defense programs. The company’s continued effective execution of funded defense backlog resulted in a 38% sequential increase in revenue from defense contracts, which more than compensated for the ongoing softness in its commercial aviation business. As a result, gross profit increased 116% to $4.2 million year over year compared to $1.9 million in the prior-year quarter. Gross profit margin expanded 330 basis points to 16.4% for the third quarter of 2020.

“Based on our solid third-quarter results, we are increasingly confident in our expectations for accelerated revenue and margin improvement for the second half of 2020 compared to the first half and for revenue growth and higher operating income for 2020 compared to 2019,” said CEO Douglas McCrosson. “Looking ahead to 2021, our $183.9 million funded defense backlog gives us a high degree of confidence to affirm our previous 2021 outlook for growth in revenue, operating income and operating cash. Our demonstrated track record of competing for and winning new opportunities should help us sustain our strong backlog, which will position us well for attractive long-term growth.”

Ennis Inc. (EBF) announced that one of its wholly owned subsidiaries agreed to acquire InfoSeal, a printing and finishing manufacturer that provides pressure seal and tax forms products to print brokers and resellers. The Ennis subsidiary will operate under the InfoSeal name, and the company expects the acquisition to be accretive to earnings in year one.

“InfoSeal is a leader in the production of pressure seal documents and this well-known brand brings added capabilities and expertise to our expanding product offering, including our existing VersaSeal pressure seal product line,” said Ennis CEO Keith Walters. “InfoSeal products are sold through our traditional sales channel of independent distributors and this business continues our strategy to support our loyal distributors with an industry-leading product offering.”

Hibbett Sports Inc. (HIBB) announced an exclusive partnership with Nike and NiceKicks.com to produce a Small-Town Sneakerhead digital campaign and video.

Hooker Furniture Corp. (HOFT) declared a regular quarterly dividend of $0.18 per share, an increase of 12.5% from its previous declaration. The dividend was payable on December 31, 2020, to shareholders of record as of December 16, 2020.

Mesa Air Group (MESA) reported fourth-quarter earnings of $0.32 per share, beating the I/B/E/S/ consensus estimate for a loss of $0.02 per share. The company brought in revenue of $108 million for the quarter, down 42.9% year over year. Cash for the quarter increased by $34.5 million to $99.4 million and the company realized capital expenditures of $1.5 million.

During the quarter the company extinguished $164 million in debt, realizing a net cash generation of $31 million. Within that $164 million debt payment the company paid off $21 million out of $28 million in principal. The company reported $3.2 million of income tax expense for the quarter but did not pay any cash taxes as it has over $500 million in a net operating loss carryforward, an accounting move that allows companies to offset income taxes with past losses. Going forward, the company is hoping to invest more in its core operations and continue to foster and grow its corporate partnerships.

Orion Group Holdings Inc. (ORN) announced contract awards totaling $20 million for its marine construction segment. The company was awarded contracts for two Florida-based projects worth about $10 million each that will start in the first quarter of 2021 and are expected to take about a year to complete.

Perion Network Ltd. (PERI) raised its financial guidance for the fourth quarter of 2020 based on an increase in new business from recent acquisitions and the renewal of its partnership with Microsoft Corp. (MSFT). Fourth-quarter revenue is now expected to increase year over year by 31%, to between $100 million to $105 million, compared to the previously expected range of $81 million to $91 million. Fourth-quarter adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) is now expected to increase 11% year over year to between $13 million and $14 million, compared to the previously expected range of $8 million to $10 million.

RCI Hospitality Holdings (RICK) reported adjusted earnings of $0.15 per share for the fourth quarter of 2020, which beat the I/B/E/S consensus estimate of $0.02 per share. Adjusted earnings were down year over year compared to $0.61 per share, but RCI Hospitality said the results were incomparable due to the impact of the coronavirus pandemic. Fourth-quarter adjusted earnings improved sequentially from the third quarter’s adjusted loss of $0.74 per share.

As previously reported, fourth-quarter revenues continued to improve sequentially from the third quarter by 98%, to $28.8 million. Both the Bombshells restaurant segment and the nightclubs segment reported sequential improvement from the third quarter, reflecting reduced restrictions on indoor occupancies and dining.

“[Fourth-quarter 2020] demonstrated our continued progress managing the effects of [the coronavirus],” said CEO Eric Langan. “This has enabled us to serve our guests, keep our teams employed, generate free cash flow and retain a healthy amount of cash on the balance sheet.”

Looking forward, RCI Hospitality expects total sales between $35 million and $37 million for the first quarter of 2021, assuming no additional closures or restrictions. At the time of the announcement, 36 locations were open—26 clubs and 10 Bombshells restaurants. The company is moving ahead with plans to open more restaurants and expects to benefit from any positive impact of the coronavirus vaccine.

RCI Hospitality declared a regular quarterly dividend of $0.04 per share, in line with its previous declaration. The dividend is payable on February 10, 2021, to shareholders of record as of January 27, 2021. The stock will trade ex-dividend on Tuesday, January 26, 2021.

Townsquare Media Inc. (TSQ) reported that net revenue declined less than expected in a preliminary release of financial results for the fourth quarter of 2020. Net revenue is expected to be in a range of $107 million to $109 million, a year-over-year decline of about 2.7% to 4.5% that compares to the expectation for a year-over-year decline of 7.5% stated during the company’s third-quarter earnings call. CEO Bill Wilson said net revenue has improved sequentially since bottoming out in the second quarter with a decrease of 35% year over year.

Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) is also expected to beat Townsquare Media’s previous guidance by about $2 million. Adjusted EBITDA for the fourth quarter is expected to be in a range of $27 million to $28 million, growth of 8.3% to 21.3% year over year.

Townsquare Media also announced a new debt offering for $550 million of notes due 2026. Proceeds will be used to repay the company’s existing notes due 2023. Townsquare Media intends to close all of its existing debt facilities, including its revolving credit facility.

VSE Corp. (VSEC) declared a regular quarterly dividend of $0.09 per share, in line with its previous declaration. The dividend is payable on February 10, 2021, to shareholders of record as of January 27, 2021. The stock will trade ex-dividend on Tuesday, January 26, 2021.