October Model Shadow Stock Portfolio Update

The bear market continued its run during September, with the S&P 500 index finishing the month down 25.3% from its all-time closing high on January 3, 2022. Examining monthly total return figures, the S&P 500 is down 24.0% over the first nine months of the year. The bear market for the Model Shadow Stock Portfolio started even sooner. The Model Shadow Stock Portfolio peaked in May 2021 and is now down 36.5% over the last 16 months.

In the first 20 years of its existence, the Model Shadow Stock Portfolio tended to have deeper bear markets, but they were significantly shorter in duration than for the S&P 500. Over the last 10 years however, the Model Shadow Stock Portfolio’s downturns have been more frequent, deeper and have taken longer to get back to even.

The deepest drawdown for the Model Shadow Stock Portfolio was during the financial crisis of 2007–2008. The Model Shadow Stock Portfolio declined 63.4%, but it broke even in 3.4 years. In contrast the S&P 500 had a total-return decline of 51.0% during the financial crisis, but it took 4.8 years to make up the drawdown. The longest drawdown period for the S&P 500 over the last 30 years occurred with the bursting of the dot-com bubble in 2000. It took 6.2 years for the S&P 500 to make up its 44.8% decline.

As shown in the chart here, the downturns for the micro-cap Model Shadow Stock Portfolio do not always match up with those of the large-cap S&P 500 index. The downturns are more frequent for the Model Shadow Stock Portfolio and often start ahead of the large-cap index declines. That difference in movement adds diversification to your portfolio over the long term while still allowing investment in stocks.

Micro-cap stocks are less liquid than large-cap stocks. The same dollar values of buying demand or selling pressure will normally move their stock prices more dramatically. That is why it is important to have a long-term investment horizon when investing in smaller companies and remember that they are not well-suited for active trading.

Investors are becoming more concerned that the tightening actions of the Federal Reserve to lower inflation will result in a recession. Employment continues to remain tight, but high interest rates are starting to take a toll on the housing market.

Housing growth has a strong multiplier impact throughout the economy as individuals need to buy items such as furniture, appliances, paint and flooring when setting up a household. Within the Model Shadow Stock Portfolio, homebuilder Beazer Homes USA Inc. (BZH) was down 32.1% during September. The September performance of related consumer companies include: Bassett Furniture Industries Inc. (BSET) down 17.7%, Container Store Group Inc. (TCS) down 27.7%, Dixie Group Inc. (DXYN) down 4.4%, Hooker Furnishings Corp. (HOFT) down 15.0% and VOXX International Corp. (VOXX) down 21.1% during September.

Overall, the Model Shadow Stock Portfolio was down 13.3% during September, its weakest month since declining 35.1% in March 2020. Only three stocks were up for the month—NACCO Industries Inc. (NC) up 4.6%, Covenant Logistics Group Inc. (CVLG) up 2.1% and Fonar Corp. (FONR) up 0.4%. The S&P 500, as measured by the Vanguard 500 Index fund (VFINX), was down 9.2% during the month and is down 24.0% for the year. The 13.3% monthly loss for the Model Shadow Stock Portfolio pushed its year-to-date return down to –29.9%. The Vanguard Small-Cap Index fund (NAESX) gave up 9.6% during the month and is posting a 23.8% loss during 2022, while the DFA U.S. Micro-Cap fund (DFSCX) lost 9.0% during September and is down 20.4% for the year.

None of the S&P 500 sectors were up during September. Health care had the smallest loss of 2.6%, while real estate suffered the greatest loss of 13.2% during the month. During the third quarter, consumer discretionary was the best-performing sector with a 4.4% gain, followed by energy (up 2.4%). Communication services was the weakest sector during the quarter (down 12.7%) followed by real estate (down 11.0%).

Energy is the only sector up year to date, with a strong gain of 34.9%. The defensive utility sector is down only 6.5% for the year followed by consumer staples, down 11.8%. The weakest sectors year to date are communication services (down 39.0%), information technology (down 31.4%) and consumer discretionary (down 29.9%).

Value held up better than growth for large caps during September, but not for the mid- and small-cap companies.

In the large-cap segment, large-cap value stocks were down 8.5% during September, contributing to a 16.6% loss year to date. Growth stocks were down 10.0% during September, giving them a 30.4% loss year to date for 2022.

In the mid-cap segment, value stocks are down 17.5% for the year, after declining 9.5% during the month. Mid-cap growth stocks are down 25.5% for the year, after declining 8.8% during September.

Small-cap value stocks are down 21.1% for the year, while small-cap growth stocks are down 29.3%. Small-cap value stocks declined by 10.2% during September, while small-cap growth stocks lost 9.0% during the month.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 13.1% versus the Vanguard 500 Index fund’s gain of 9.3% per year on average over the same period. Over the same period, the Vanguard Small-Cap Index fund also posted an average annual gain of 9.3%.

Monthly Observations

Forty-three stocks met the initial selection criteria for the Model Shadow Stock Portfolio as of October 12, 2022, up from 35 passing stocks one month ago. 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 43 qualifying companies, 12 were held in the Model Shadow Stock tracking portfolio at the time:

Bassett Furniture, Beazer Homes, Big 5 Sporting Goods Corp. (BGFV), Container Store, Delta Apparel Inc. (DLA), Fonar, Hooker Furnishings, Hurco Companies Inc. (HURC), Key Tronic Corp. (KTCC), Pangaea Logistics Solutions Ltd. (PANL), Rocky Brands Inc. (RCKY) and Strattec Security Corp. (STRT).

Bassett Furniture (last qualified February 2022), Beazer Homes (last qualified March 2019) and Big 5 Sporting Goods (last qualified June 2022) were the three new additions to the list of currently qualifying portfolio holdings since last month.

Two stocks came off the passing group since last month. NACCO Industries’ market capitalization of $355.4 million is just above the $350 million qualifying maximum. SigmaTron International Inc.’s (SGMA) market cap of $27.5 million just crosses below the $30 million initial qualifying minimum.

As of October 12, Perion Network Ltd. (PERI) had the highest price-to-book ratio in the Model Shadow Stock Portfolio. Its price-to-book ratio of 1.99 remains well below the threshold for removing a stock. Shadow stocks with a price-to-book ratio three times the initial maximum (0.90 × 3 = 2.70) at the time of a quarterly review are removed from the portfolio, assuming there is a suitable replacement.

Perion Network also has the highest market cap value of $987.1 million as of October 12. Perion Network is an Israel-based global technology company that delivers online advertising solutions and search monetization to brands and publishers. The Model Shadow Stock Portfolio looks for stocks with a market cap (share price times shares outstanding) greater than $30 million but less than $350 million when adding stocks to the portfolio. Shadow stocks with a market cap three times the initial market cap maximum ($350 million × 3 = $1.05 billion) at the time of a quarterly review are sold from the portfolio, assuming there is a suitable replacement.

Next Portfolio Review

The initial market cap and price-to-book levels are adjusted over time to reflect the changing market conditions. The next quarterly review of the Model Shadow Stock Portfolio will take place following the end of November 2022. 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

NACCO Industries Inc. (NC) was the top-performing stock in the portfolio for the month of September, up 4.6%. There was no company-specific news during the month.

Covenant Logistics Group Inc. (CVLG) was the second-best-performing stock in the portfolio for the month of September, up 2.1%. There was no company-specific news during the month.

SigmaTron International Inc. (SGMA) was the worst-performing stock in the portfolio for September, down by 38.2%. The company reported first-quarter 2023 earnings during the quarter.

Beazer Homes USA Inc. (BZH) was the second-worst-performing stock in the portfolio for the month of September, down 32.1%. There was no company-specific news during the month.

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

Advanced Emissions Solutions Inc. (ADES) announced the sale of subsidiary Marshall Mine LLC to Caddo Creek Resources Company LLC. Advanced Emissions Solutions does not expect to receive any cash proceeds from the transaction. As a result of the transaction, Caddo Creek Resources will assume Marshall Mine’s assets as well as the asset retirement obligation related to the mine of $4.8 million. Upon completion of the transaction, Advanced Emissions Solutions expects to record a gain of approximately $2.4 million. The closing of the transaction is subject to certain customary closing conditions, including obtaining applicable regulatory approvals.

Bassett Furniture Industries Inc. (BSET) announced its third-quarter 2022 financial results. The company reported diluted earnings per share of $0.82, beating the I/B/E/S consensus estimate of $0.64 per share by 28.1%. Net income for the quarter was $7.6 million, an increase over $3.0 million in same period of 2021. Net sales for the quarter totaled $118 million, a 12.5% increase over the comparable quarter of 2021. Gross profit for the quarter increased 15.6% over 2021, up to $60.8 million. Operating income for the quarter was $10.7 million, a 114.0% increase from a year ago.

During the month, the company also announced the acquisition of Noa Home Inc., a Canada-based furniture, mattress and accessories online retailer in four markets: Australia, Singapore, the U.K. and Canada. Net revenue for the current fiscal year was 19.1 million Canadian dollars (about $14 million). The company plans to introduce Noa Home to U.S. markets sometime in 2023.

Ennis Inc. (EBF) reported second-quarter 2022 earnings per share of $0.47, which increased year over year from $0.29 per share. Net sales of $111.2 million increased by 10.7% over the same period. For the second quarter, the company’s gross margin was 31.7% and operating margin was 15.5%, compared to a gross margin of 28.8% and an operating margin of 10.8% in the same period of fiscal-year 2021. Earnings beat the I/B/E/S consensus estimate of $0.39 per share by 20.5%.

The board of directors declared a quarterly cash dividend of $0.25 per share on the company’s common stock. The dividend is payable on November 4 to shareholders of record as of October 7.

Fonar Corp. (FONR) reported fiscal-year 2022 earnings per share of $1.66, which increased year over year from $1.37 per share. Net sales of $97.6 million increased by 8.6% over the same period. For the year, the company’s gross margin was 48.2% and operating margin was 22.5%, compared to a gross margin of 48.4% and an operating margin of 19.0% in fiscal-year 2021. 

Hooker Furnishings Corp. (HOFT) reported second-quarter 2023 earnings per share of $0.46, which decreased year over year from $0.62 per share. Net sales of $152.9 million decreased by 5.9% over the same period. Earnings beat the I/B/E/S consensus estimate of $0.44 per share by 4.5%. For the second quarter, the company’s gross margin was 20.3% and the operating margin was 4.8%, compared to a gross margin of 19.5% and an operating margin of 5.9% in the same period of fiscal-year 2022.

The company also declared a regular quarterly dividend of $0.20 per share, which was paid on September 30 to shareholders of record as of September 19.

Hurco Companies Inc. (HURC) reported third-quarter 2022 earnings per share of $0.18, which decreased year over year from $0.20 per share. Net sales of $57.6 million increased by 6.4% over the same period.

For the third quarter, the company’s gross margin was 24.9% and the operating margin was 3.0%, compared to a gross margin of 23.9% and an operating margin of 4.9% in the same period of fiscal-year 2021.

The company’s board of directors approved the payment of a $0.15 per share cash dividend on its issued and outstanding common stock. The dividend will be paid on October 17 to shareholders of record as of the close of business on October 3.

SigmaTron International Inc. (SGMA) reported first-quarter 2023 revenues of $105.5 million, which is up 23% from the same period a year prior. The company reported earnings per share of $0.23, down from $2.06 per share in the prior-year period. SigmaTron International reported a pretax profit of $1.9 million, which included an expected pretax loss of $2.2 million from its pet-tech Internet of Things (IoT) start-up, Wagz. The loss from Wagz and first-quarter 2022’s included one-time gain of $6.3 million from the Paycheck Protection Program (PPP) loan forgiveness made it difficult to compare to first-quarter 2023. The pretax profit for the first quarter of fiscal-year 2022 was $9.6 million.

Titan Machinery Inc. (TITN) announced the appointment of Robert Larsen as its new chief financial officer (CFO), effective December 1, 2022. Larsen joins Titan Machinery from CNH Industrial N.V. (CNHI), where he currently serves as the head of finance.

Ultralife Corp. (ULBI) received a contract valued at approximately $7.5 million to supply its integrated system of A-320 amplifiers and A-320HVA radio vehicle mounts to a major international defense contractor for an ongoing government/defense modernization program. Deliveries are expected to commence in the fourth quarter of 2022 and continue through the first half of 2023.

VOXX International Corp. (VOXX) launched its new e-commerce platform, a project long under development. The first official rollout is with its subsidiary, Premium Audio Company LLC, which has integrated new tools for ease of use.

“As we grow organically and continue to acquire and integrate, it’s essential that we consider all customer touch points and have the best infrastructure in place to support them,” stated president and CEO Pat Lavelle. “Our new e-commerce platform will improve call times, data collection, routing, shipping information and more, and most importantly, lead to better customer satisfaction at the point of sale and the post-sale experience.”