John Bajkowski
is the president of AAII.
The Model Shadow Stock Portfolio is reviewed quarterly to determine portfolio sales and additions, a practice put in place since the portfolio’s inception in 1993.
Occasionally, a special situation arises that requires more immediate action. On July 23, Model Shadow Stock Portfolio holding New Home Company Inc. (NWHM) announced that it had entered into a definitive merger agreement to be acquired by Apollo Funds, which is managed by affiliates of Apollo Global Management Inc. Under the terms of the agreement, Apollo Funds offered to acquire all outstanding shares of New Home Company for $9.00 per share in cash.
The tender offer was set to expire at the end of September 7, 2021. The acquisition transforms the company into a privately held enterprise, so shareholders needed to tender their shares or sell their stock ahead of the tender offer expiration.
The model portfolio position in New Home Company was sold, and a sell alert was issued on August 16. New Home Company was sold since the market price largely reflected the acquisition price of $9.00 per share, and we could be ready to reinvest the proceeds ahead of the quarterly portfolio review.
The quarterly review cycle of the Model Shadow Stock Portfolio is tied to the reporting cycle of most domestic publicly traded firms. After the reporting cycle is complete, holdings are examined for violating the earnings, valuation, size and age rules of the Model Shadow Stock Portfolio.
The review begins with an examination of the breakpoints for the smallest and cheapest deciles of domestically listed stocks. 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-value (P/B) ratio. These decile breakpoints are determined by examining domestic companies that are listed on the New York Stock Exchange (NYSE) and then applying the size and value breakpoints for stocks listed on all domestic exchanges.
We used AAII’s Stock Investor Pro to examine the decile maximums and are leaving them unchanged. The NYSE price-to-book cutoff was 1.06 at the end of August, down from 1.11 in June, not significant enough to warrant a revision. The maximum minimum initial price-to-book ratio for determining qualifying stocks remains at 1.10. Stocks are sold for valuation if they exceed three times the minimum initial price-to-book ratio at the time of a quarterly portfolio review. A price-to-book cutoff of 1.10 is used to screen for stocks to add to the Model Shadow Stock Portfolio and 3.30 (1.10 × 3) is the maximum price-to-book ratio to keep stocks in the portfolio.
The NYSE market-cap cutoff for the lowest decile was $460 million at the end of August, compared to $470 million in June. Here again the size change was not significant enough merit an adjustment. The maximum minimum initial market capitalization for determining qualifying stocks remains at $500 million. Stocks are sold for valuation if they exceed three times the minimum initial market cap at the time of a quarterly portfolio review. A market-cap cutoff of $500 million is used to screen for stocks to add to the Model Shadow Stock Portfolio and $1,500 million ($500 million × 3) is the maximum market cap to keep stocks in the portfolio.
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 is a new qualifying stock to replace it.
After conducting the quarterly review of the Model Shadow Stock Portfolio, Hibbett Inc. (HIBB) was removed from the tracking portfolio during regular trading hours on Thursday, September 9. With the proceeds from the sale of Hibbett and New Home Company, as well as the cash held in the portfolio, there were enough funds to purchase three new holdings at a level roughly matching the average position—Dixie Group Inc. (DXYN), Rayonier Advanced Materials 
(RYAM) and VOXX International Corp. (VOXX).
Hibbett Inc. (HIBB)
Hibbett has been bumping up against the valuation and size maximums of the Model Shadow Stock Portfolio for some time now. Hibbett, formerly Hibbett Sports, is a leading athletic-inspired fashion retailer with nearly 1,100 Hibbett Sports and City Gear specialty stores. Hibbett, headquartered in Birmingham, Alabama, operates stores in 35 states nationwide primarily in small and mid-sized markets in the South, Southwest, Mid-Atlantic and the Midwest regions of the U.S.
Hibbett has benefited from increased at-home recreational activity triggered by the coronavirus pandemic. The stock is trading at around 15% off of its 52-week high price but is up over 85% for the year as of September 7. At the time of our quarterly review, Hibbett exceeded the market-cap sell cutoff of $1.5 billion with a market cap of $1.58 billion. It is the policy of the Model Shadow Stock Portfolio to sell a stock once its market cap reaches three times the initial purchase limit, which is now $500 million.
As of September 7, 27 stocks met the initial selection criteria for the Model Shadow Stock Portfolio. This is up from 20 passing companies last month. 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.
Seven stocks already in the Model Shadow Stock Portfolio passed the updated criteria at the time of the review: Ampco-Pittsburgh Corp. (AP), Hurco Companies Inc. (HURC), Key Tronic Corp. (KTCC), Mesa Air Group (MESA), Orion Group Holdings Inc. (ORN), SIFCO Industries Inc. (SIF) and Strattec Security Corp. (STRT).
The remaining 20 stocks were examined to ensure adequate liquidity, timely financial filings and appropriate industry and foreign considerations. A real estate investment trust (REIT) and a limited partnership were excluded. A company headquartered in China was excluded from consideration. Six stocks were also excluded from consideration because their average daily dollar trading volume was too low, indicating that they might be difficult to purchase without severely impacting the share price. The Shadow Stock Portfolio Rules on AAII.com provides guidance of factors to consider when selecting stocks for your portfolio.
Price momentum is used as the tiebreaker among qualifying stocks. The remaining stocks were ranked using the weighted relative strength ranking, which considers price performance over the last year but places a higher weight on the most recent quarterly price performance.
With the proceeds from Hibbett and New Home Company sales and the existing cash position of the Model Shadow Stock Portfolio, there were enough funds to take a position in three companies at roughly the average position size for the existing holdings in the tracking portfolio. The portfolio additions are:
Dixie Group Inc. (DXYN)
Dixie Group is a marketer and manufacturer of carpet and rugs to high-end residential customers through the Fabrica International, Masland Residential and Dixie Home brands. High-end carpet and rugs for commercial applications are marketed by AtlasMasland.
Dixie Group has a book value per share of $4.34 as of June 26. If you wish to stay within the 1.10 price-to-book-value maximum, you should pay no more than $4.77 per share (4.34 × 1.10). 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 1.21, which equates to a price of $5.25 per share. To calculate the maximum purchase price based on the maximum desired price-to-book ratio, multiply the current book value per share ($4.34 for Dixie Group) by the maximum price-to-book ratio to be considered for the Model Shadow Stock Portfolio (currently 1.10, or 1.21 for loosened consideration).
Rayonier Advanced Materials (RYAM)
Rayonier Advanced Materials is global supplier of high-purity cellulose specialties products, a natural polymer for the chemical industry. The company’s facilities in the U.S., Canada and France can produce over one million metric tons of high purity cellulose products for use in a wide range of industrial and consumer products such as filters, cosmetics, textiles and pharmaceuticals. Additionally, the company produces lumber for use in building and construction, as well as pulp and paper products used in packaging, print and writing materials.
Rayonier Advanced Materials has a book value per share of $12.36 as of June 26. If you wish to stay within the 1.10 price-to-book-value maximum, you should pay no more than $13.60 per share (12.36 × 1.10). 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 1.21, which equates to a price of $14.95 per share.
VOXX International Corp. (VOXX)
VOXX International is an international manufacturer and distributor in the automotive electronics, consumer electronics and biometrics industries. VOXX International’s segments include automotive electronics, consumer electronics and biometrics. The automotive electronics segment designs, manufactures, distributes and markets rear-seat entertainment devices, automotive security, mobile multimedia devices, location-based services, turn signal switches, obstacle-sensing systems, cruise control systems, heated seats and satellite radio products. The consumer electronics segment designs, manufactures, distributes and markets home theater systems; outdoor, cinema, flat panel, wireless and Bluetooth speakers; remote controls; karaoke products; personal sound amplifiers; infant and nursery products; and digital consumer products. The biometrics segment designs, markets and distributes iris identification and biometric security-related products.
VOXX International has a book value per share of $16.90 as of May 31. If you wish to stay within the 1.10 price-to-book-value maximum, you should pay no more than $18.59 per share (16.90 × 1.10). 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 1.21, which equates to a price of $20.45 per share.
The next quarterly review of the Model Shadow Stock Portfolio will take place following the end of November 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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