John Bajkowski
is the president of AAII.
Barring a Santa Claus rally during the last two weeks of December, the market is poised to finish in the red for all of 2022. The market’s collective gaze on the actions of the Federal Reserve and its desire to tame persistent inflation helped fuel a stampede for the exit as the market anticipates a longer and more severe period of Fed tightening. Higher interest rates are more likely to persist, and investors are still trying to understand how that might impact the economic and investing landscape.
The Model Shadow Stock Portfolio has been more volatile historically than the market, with deeper and more sudden downward dips normally followed by more pronounced upward moves. The Model Shadow Stock Portfolio gained 24.3% during October and November, compared to a 14.1% gain for the S&P 500 index as measured by the performance the Vanguard 500 Index fund 
(VFINX). The strong increase helped to trim the year-to-date loss for the Model Shadow Stock Portfolio to 12.8% through the end of November. The Vanguard 500 Index fund is down 13.2% for the first 11 months of the year. The Vanguard Small Cap Index fund (NAESX) is down 12.5% for the year.
Small-cap stocks remain attractively priced relative to large-cap stocks. The median price-to-book value ratio of the companies in the S&P SmallCap 600 index is 1.76 ratio, roughly half of the 3.48 median ratio for the companies in the S&P 500. The S&P SmallCap 600 normally trades at a discounted multiple relative to the S&P 500. The discount has averaged 0.67 since 1998. The difference was smallest during 2006 when the discount was only 0.79 times (2.28 compared to 2.89) and has been persistently around 0.50 to 0.51 during 2022.
Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 13.9%, versus the Vanguard 500 Index fund’s gain of 9.8% 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 9.8%, and the DFA US Micro Cap fund (DFSCX) returned 11.0%.
The Model Shadow Stock Portfolio has been more volatile than the Vanguard 500 Index fund. It’s annualized standard deviation of monthly returns from inception is 21.8%, 46% higher than the 14.9% standard deviation of the Vanguard 500 Index fund. By way of comparison, the standard deviation of Vanguard Small Cap fund is 19.0% and the DFA US Micro Cap fund 20.4% over the same time period.
The performance of growth- versus value-oriented stocks was again slanted toward value stocks during the month. In the large-cap segment, value stocks were up 6.0% for the month, trimming their year-to-date loss to 1.4% for 2022. Large-cap growth stocks remain weaker year to date with a 23.6% loss after gaining 5.1% during November.
In the mid-cap segment, value stocks are down 2.1% for the year, after gaining 6.5% during November. Mid-cap growth stocks are down 13.8% for the year, after gaining 5.7% during the month.
Small-cap value stocks are down 8.5% year to date, while small-cap growth stocks are down 21.3%. During November, small-cap value stocks gained 3.0% and small-cap growth stocks gained 1.6%.
All of the sectors posted gains during November, led by materials, which was up 11.8% during the month. There are now three sectors in the green for the year. Energy remains the leader with its 69.7% year-to-date gain. The utilities sector is second with a 2.1% gain, while consumer staples are up 2.1% for the year through November.
Sectors that are lagging this year include communication services (down 33.2%), consumer discretionary (down 28.0%), real estate (down 22.4%) and technology (down 21.1%).
The strongest sectors during November include materials (up 11.8%), industrials (up 7.9%), financials (up 7.0%) and utilities (up 7.0%).
The weakest sectors during the month were energy (1.4%), consumer discretionary (up 1.5%), health care (up 4.8%) and consumer staples (up 6.2%).
The Model Shadow Stock Portfolio is reviewed quarterly to determine portfolio sales and additions. The quarterly review cycle is tied to the reporting cycle of most firms and limits costly portfolio turnover.
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.
Value
The price-to-book cutoff has decreased slightly from 0.88 in September to 0.84. The current initial qualifying maximum price-to-book ratio is 0.90 and we left it unchanged. Qualifying stocks must have a price-to-book ratio of 0.90 or lower when added to the model portfolio. Stocks in the model portfolio are sold for valuation if they exceed three times the initial maximum price-to-book ratio at the time of a quarterly portfolio review.
No stocks in the Model Portfolio were exceeded the maximum price-to-book ratio at the time of review.
Size
We also examined the market-cap levels of the companies listed on the NYSE to determine the size cutoff for the lowest decile when adding stocks to the model portfolio. The decile market-cap level declined from $330 million in September to $300 million. Therefore, we reduced the maximum initial qualifying market-cap value from $350 million to $300 million. We consider stocks with a market cap of $300 million and below. Holdings are sold if their market cap goes above three times the initial criterion at the time of the quarterly review: $900 million.
Size Deletion: Perion Network Ltd. (PERI)
Perion Network exceeded the market-cap sell cutoff of $900 million with a market cap of $1.155 billion and was removed from the portfolio. Perion Network was purchased for the Model Shadow Stock Portfolio on December 13, 2019, at a purchase price of $5.36. It was sold on December 12, 2022, for $25.385 per share, for a gain of 373.5%.
Earnings
If a company has 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.
Earnings Deletion: Dixie Group Inc. (DXYN)
Dixie Group went on earnings probation after reporting a loss of $0.29 per share for its 2022 second quarter. On November 3, 2022, Dixie Group reported a quarterly loss of $0.55 per share for its third quarter, while still on earnings probation. Dixie Group was purchased for the Model Shadow Stock Portfolio on September 9, 2021, at an average cost of $4.50. It was sold on December 12, 2022, for $1.06 per share, for a loss of 76.4%.
Earnings Deletion: Ultralife Corp. (ULBI)
Ultralife went on earnings probation after the first quarter of 2022. The company reported positive quarterly earnings for the second quarter but a loss of $0.01 per share during the third quarter, while still on earnings probation. Ultralife was purchased for the Model Shadow Stock Portfolio on March 8, 2021, at a purchase price of $6.76. It was sold on December 12, 2022, for $4.31 per share, for a loss of 36.2%.
Age
We also examine the portfolio for stocks that have been held for at least four years and have not had strong price appreciation. We normally remove holdings that no longer qualify and have not gained at least 10% annually. Howe er with the recent bear market environment, we limited our examination to portfolio holdings held longer than four years and that are down from their original purchase price.
Age Deletion: Delta Apparel, Inc. (DLA)
Delta Apparel was added to the Model Shadow Stock Portfolio on August 31, 2017, at a purchase price of $20.01 per share. It hit a high of $35.26 during April 2021 but saw its share price come under pressure this year as the firm responded to labor shortages, inflationary pressures and supply chain disruptions. Delta Apparel has been held for just over 5.25 years, is down from its purchase price and does not currently qualify. It was sold on December 12, 2022, at $11.20 per share, for a loss of 44.0%.
As of December 12, 30 stocks met the initial selection criteria for the Model Shadow Stock Portfolio. 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.
Ten qualifying stocks were already in the Model Shadow Stock Portfolio at the time of the review. The remaining 20 stocks were examined to ensure adequate liquidity, timely financial filings and appropriate industry and foreign considerations. The Shadow Stock Portfolio Rules on AAII.com provides guidance on factors to consider when selecting stocks for your portfolio.
With the proceeds from the sales, as well as the cash held in the portfolio, we were able to take positions in six companies at roughly the average position size for the existing holdings in the tracking portfolio.
Clarus Corp. (CLAR)
Clarus is a leading developer, manufacturer and distributor of best-in-class outdoor equipment and lifestyle products focused on the climb, ski, mountain and sport markets. Clarus has a book value per share of $9.72 as of September 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $8.75 per share ($9.72 × 0.90). 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 1.00, which equates to a price of $9.72 per share. To calculate the maximum purchase price based on the maximum desired price-to-book ratio, multiply the current book value per share ($9.72 for Clarus) by the maximum price-to-book ratio to be considered for the Model Shadow Stock Portfolio (currently 0.90, or 1.00 for loosened consideration).
Core Molding Technologies, Inc. (CMT)
Core Molding Technologies operates in the engineered materials market as a molder of thermoplastic and thermoset structural products. Core Molding Technologies has a book value per share of $12.92 as of September 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $11.63 per share ($12.92 × 0.90). 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 1.00, which equates to a price of $12.92 per share.
Escalade Inc. (ESCA)
Escalade designs, manufactures and sells sporting goods, fitness and indoor/outdoor recreation equipment. Escalade has a book value per share of $11.57 as of October 1. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $10.41 per share ($11.57 × 0.90). 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 1.00, which equates to a price of $11.57 per share.
Friedman Industries Inc. (FRD)
Friedman Industries is a manufacturer and processor of steel products in two segments coil products and tubular products. Friedman Industries has a book value per share of $14.73 as of September 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $13.26 per share ($14.73 × 0.90). 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 1.00, which equates to a price of $14.73 per share.
Lazydays Holdings Inc. (LAZY)
Lazydays Holdings operates recreational vehicle (RV) dealerships and offers a portfolio of products and services for RV owners and outdoor enthusiasts. Lazydays Holdings has a book value per share of $20.85 as of September 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $18.77 per share ($20.85 × 0.90). 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 1.00, which equates to a price of $20.85 per share.
Mistras Group Inc. (MG)
Mistras Group is a multinational provider of integrated technology-enabled asset protection solutions, helping to maximize the safety and operational uptime for critical industrial and civil assets. Mistras Group has a book value per share of $6.23 as of September 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $5.61 per share ($6.23 × 0.90). 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 1.00, which equates to a price of $6.23 per share.
The next quarterly review of the Model Shadow Stock Portfolio will take place following the end of February 2022. 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).
(11/29/2022)
Delta Apparel announced that Justin Grow has rejoined the company in the roles of executive vice president and chief administrative officer. Grow will work closely with the company’s CEO and board of directors on strategic and corporate development initiatives; oversee the company’s legal, compliance, human resources and administrative functions; and assist with investor relations efforts.
(11/17/2022)
Delta Apparel announced its fourth-quarter and full-year 2022 results. The company reported a loss per diluted share of $0.04, missing the I/B/E/S consensus estimate for earnings of $0.61 per share by 106.6%. The company reported full-year earnings per diluted share of $2.80, a slight decline from $2.86 per diluted share in 2021.
Net sales for the quarter totaled $115.5 million, just above 2021’s fourth quarter of $114.7 million. Operating income for the quarter was $2.2 million, down 78.0% from the comparable period of 2021. Net loss for the quarter was $0.28 million, down signficantly from net income of $6.85 million a year ago.
Hooker Furnishings Corporation (HOFT)
(12/08/2022)
Hooker Furnishings reported third-quarter 2023 earnings per share of $0.42, which increased year over year from a loss of $0.10 per share. Net sales of $151.6 million rose 13.6% over the same period. Gross margin was 21.1% and operating margin was 4.1% for the quarter, compared to a gross margin of 15.0% and an operating margin of –1.3% in the same period of fiscal-year 2022.
CEO Jeremy Hoff commented, “Steady fulfillment of backlogs, full production capacity, healthier inventory levels and operational improvements positively impacted our revenues this quarter.”
(12/06/2022)
Hooker Furnishings’ board of directors declared a quarterly cash dividend of $0.22 per share, payable on December 30 to shareholders of record as of December 16. This represents a 10% increase over the previous quarterly dividend and the seventh consecutive annual dividend increase.
(11/15/2022)
Hurco Companies announced that its board of directors approved the payment of a cash dividend of $0.15 per share on its issued and outstanding common stock. The dividend will be paid on January 17, 2023, to shareholders of record as of January 3. The stock will trade ex-dividend on December 30, 2022.
(11/30/2022)
Titan Machinery reported third-quarter 2022 diluted earnings per share of $1.83, beating the I/B/E/S consensus estimate of $1.16 by $0.67 per share, or 57.8%. Net income for the quarter totaled $41.2 million, an 89% increase over $21.8 million in the comparable period last year. Net sales also increased, up 40.8% to $508.9 million for the quarter from $361.5 million in the third quarter of 2021. Operating income totaled $54.7 million, an 89% increase from $28.8 million a year ago.
(11/28/2022)
Ultralife appointed Michael E. Manna as president, CEO and a member of the board of directors, effective immediately. He replaces Michael D. Popielec, who will remain until January 20, 2023, to ensure a smooth transition.
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