John Bajkowski
is the president of AAII.
The Model Shadow Stock Portfolio is reviewed quarterly to determine stock sales and additions, a practice put in place since the portfolio’s inception in 1993. The quarterly portfolio review cycle is tied to the standard reporting cycle of most publicly traded firms in the U.S. Companies are examined for violating the earnings, valuation, size and age rules of the Model Shadow Stock Portfolio.
The primary Model Shadow Stock Portfolio selection criteria target the intersection of the smallest 10% of domestic stocks as measured by market capitalization, along with the “cheapest” 10% of domestic stocks as measured by the price-to-book (P/B) ratio. These decile breakpoints are determined by examining domestic companies that are listed on the New York Stock Exchange (NYSE) and change over time.
As the quarterly review was conducted at the start of March, the NYSE price-to-book-value cutoff was 1.02, near the portfolio’s current maximum initial price-to-book ratio of 1.00. Therefore, the maximum price-to-book value was left unchanged at 1.00 for initial inclusion and 3.00 (three times the initial criterion) as the maximum level for a stock held in the portfolio at the time of a quarterly portfolio review.
The NYSE market-cap cutoff for the lowest decile is currently $370 million, compared to the portfolio’s $300 million maximum in December, so the size cutoff was adjusted for the Model Shadow Stock Portfolio during the quarterly review from $300 million to $400 million. The maximum market cap for inclusion in the Model Shadow Stock Portfolio is now $400 million, and holdings are sold if their market cap goes above three times the initial criterion at the time of the quarterly review: $1,200 million.
The other major factor that leads to portfolio turnover is tied to negative earnings. If a company reports trailing 12-month earnings from continuing operations that are negative, the stock is placed on probation; if a subsequent quarter has negative earnings prior to trailing 12-month earnings becoming positive, the stock is sold. When available, adjusted (non-GAAP) earnings are used to put stocks on probation or sell them. These are earnings that have been adjusted to eliminate the impact of nonrecurring events such as markdown of inventory or goodwill. These are earnings reported in the media and firms reporting consensus estimates. The I/B/E/S adjusted earnings reported in Stock Investor Pro are used for Model Shadow Stock Portfolio decisions when they are available.
A stock can also be sold if it has been held over four years, if it also no longer meets the initial rules for qualifying and has not gained at least 10% annually from its purchase price and there if is a new qualifying stock to replace it.
After conducting the quarterly review of the Model Shadow Stock Portfolio, RCI Hospitality Holdings Inc. (RICK) and Townsquare Media Inc. (TSQ) were removed from the tracking portfolio during regular trading hours on Monday, March 8, 2021. With the proceeds from these two sales, as well as the cash held in the portfolio, two new stocks were added to the Model Shadow Stock Portfolio. SIFCO Industries Inc. (SIF) and Ultralife Corp. (ULBI) were added to the model portfolio during regular trading hours on Monday, March 8, 2021.
RCI Hospitality Holdings Inc. 
(RICK)
When conducting the quarterly review with data as of March 5, 2021, RCI Hospitality Holdings exceeded the price-to-book ratio sell cut-off of 3.00 with a price-to-book ratio of 3.67. It is the policy of the Model Shadow Stock Portfolio to sell a stock if its price-to-book-value ratio exceeds three times the initial purchase limit, which is currently 1.00.
RCI Hospitality Holdings owns and operates gentlemen’s clubs and sports bars/restaurants. The company has seen its price increase 248.5% over the last 52 weeks, pushing up its price-to-book ratio.
Townsquare Media Inc. (TSQ)
When conducting the quarterly review with data as of March 5, 2021, Townsquare Media exceeded the price-to-book ratio sell cut-off of 3.00 with a price-to-book ratio of 3.10. It is the policy of the Model Shadow Stock Portfolio to sell a stock if its price-to-book ratio exceeds three times the initial purchase limit, which is currently 1.00.
Townsquare Media is a media, entertainment and digital marketing solutions company principally focused on small and mid-sized markets across the U.S. Its price-to-book ratio has risen due to a combination of rising price and declining book value per share. Townsquare Media’s price has increased 123.6% over the last 26 weeks, but negative GAAP earnings have contributed to a decline in retained earnings, pushing up its price-to-book ratio.
As of March 5, five stocks met the initial selection criteria for the Model Shadow Stock Portfolio, down from 10 stocks one month ago. As noted last month, surging interest in small caps has resulted in a decline in the number of qualifying companies. 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 new Shadow Stock Ideas is updated daily—Tuesday through Saturday.
One of the qualifying stocks is already held in the model portfolio: Key Tronic Corp. (KTCC). The remaining four stocks were examined to ensure adequate liquidity, timely financial filings and appropriate industry and foreign considerations. For example, the Shadow Stock Portfolio Rules currently exclude companies in the rental and leasing industry. Price momentum is used as the tiebreaker among qualifying stocks. Stocks were ranked using the weighted relative strength ranking, which looks at price performance over the last year but places a higher weight on the most recent quarterly price performance.
SIFCO Industries Inc. (SIF)
SIFCO Industries is engaged in the production of forgings and machined components for the aerospace, defense and energy markets. SIFCO Industries supplies flight-critical forged components and machined assemblies to all of the leading aircraft and engine manufacturers. These components are used on commercial and military fixed-wing aircraft as well as helicopters and business jets. SIFCO products are also supplied to the leading steam and gas turbine manufacturers and oil producers serving the energy sector.
SIFCO Industries has a book value per share of $8.63 as of December 31, 2020. If you wish to stay within the 1.00 price-to-book-value maximum, you should pay no more than $8.63 per share. However, if the stock price has moved up after being added to the portfolio, you can still purchase the stock unless the price-to-book ratio goes above 1.10, which equates to a price of $9.49 per share. To calculate the maximum purchase price based on the maximum desired price-to-book ratio, multiply the current book value per share ($8.63 for SIFCO) by the maximum price-to-book ratio to be considered for the Model Shadow Stock Portfolio (currently 1.00, or 1.10 for loosened consideration).
Ultralife Corp. (ULBI)
Ultralife offers products and services ranging from power solutions to communications and electronics systems to customers across the globe in the government and defense; medical, safety and security; energy; industrial and robotics sectors. The company designs and manufactures power and communications systems, including rechargeable and non-rechargeable batteries, charging systems, communications and electronics systems and accessories and custom engineered systems.
Ultralife has a book value per share of $7.33 as of December 31, 2020. If you wish to stay within the 1.00 price-to-book-value maximum, you should pay no more than $7.33 per share. However, if the stock price has moved up after being added to the portfolio, you can still purchase the stock unless the price-to-book ratio goes above 1.10, which equates to a price of $8.06 per share.
The next quarterly review of the Model Shadow Stock Portfolio will take place following the end of May 2021. Any changes to the portfolio will be announced at the time they are made in our Model Shadow Stock Portfolio Update emails (sign up at www.aaii.com/email).
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