September Model Shadow Stock Portfolio Update and Changes

The Model Shadow Stock Portfolio is reviewed quarterly to determine portfolio deletions and additions, a practice put in place since the portfolio’s inception in 1993. 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 meeting the size, valuation, earnings and age deletion rules for the Model Shadow Stock Portfolio. The review this quarter was conducted as investor sentiment turned bearish during August and early September.

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. Professor Kenneth R. French provides a historical review of the breakpoints on his Dartmouth faculty website. We also calculate these breakpoints using AAII’s Stock Investor Pro stock screening and analysis software program.

The NYSE price-to-book lowest decile cutoff is unchanged at 0.85. The current initial qualifying maximum price-to-book ratio is 0.90, and we are leaving it unchanged. Qualifying stocks must have a price-to-book ratio of 0.90 or lower. Stocks in the model portfolio are removed for valuation if they exceed three times the minimum initial price-to-book ratio at the time of a quarterly portfolio review. In other words, for this quarter’s review, we use a price-to-book cutoff of 0.90 to screen for stocks to add to the Model Shadow Stock Portfolio and 2.70 (0.90 × 3) as the maximum price-to-book ratio to keep stocks in the portfolio.

As of September 13, 2023, Core Molding Technologies Inc. (CMT) had the highest price-to-book ratio in the Model Shadow Stock Portfolio. Its price-to-book ratio of 1.66 is below the 2.70 value used to remove stocks from the model portfolio. Therefore, no stocks are being deleted this quarter for exceeding the valuation limit of the model portfolio.

We then examined market-cap levels of the companies listed on the NYSE to determine the size cutoff for the lowest decile when stocks are added to the model portfolio. The decile market-cap level declined from $285 million in June to $270 million. We are, however, keeping the maximum initial qualifying market cap value at $300 million. The maximum market cap for inclusion in the Model Shadow Stock Portfolio is $300 million, and holdings are removed if their market cap goes above three times the initial criterion at the time of the quarterly review: $900 million.

VSE Corp. (VSEC) has the highest market cap in the portfolio, with a value of $893.3 million as of September 13, 2023. Its market cap was just below the removal level of $900 million, so no stocks are being deleted this quarter for exceeding the market-cap limit of the model portfolio. VSE Corp. is a diversified aftermarket products and services company operating in the aviation, fleet and federal defense segments.

Beazer Homes USA Inc. (BZH) was also close to breaking through the market cap ceiling with a market cap of $842.7 million. Beazer Homes is a geographically diversified homebuilder with operations in the West, East and Southeast.

The other factor that leads to portfolio turnover is tied to negative earnings. If a company has negative trailing 12-month earnings from continuing operations, the stock is placed on probation; if a subsequent quarter has negative earnings prior to trailing 12-month earnings becoming positive, the stock is removed. When available, adjusted (non-GAAP) earnings are used to put stocks on probation or remove 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 press and by firms that compile 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. If the company is not tracked by I/B/E/S analysts, then we use the normalized earnings as determined by Refinitiv and reported in Stock Investor Pro.

Coming into this quarter, Container Store Group Inc. (TCS), Hooker Furnishings Corp. (HOFT), SigmaTron International Inc. (SGMA), Strattec Security Corp. (STRT) and VOXX International Corp. (VOXX) were on earnings probation.

Hooker Furnishings reported positive adjusted earnings per share of $0.07 for the quarter. While the figure was not strong enough to pull trailing 12-month earnings into positive territory, the stock will stay in the model portfolio. However, it remains on earnings probation.

SigmaTron International reported normalized earnings per share of $2.095, pushing trailing 12-month earnings into the black and taking the stock off earnings probation.

Container Store Group, Strattec Security and VOXX International reported quarterly losses during the quarter and were removed from the Model Shadow Stock Portfolio on September 14, 2023.

Deletion Alerts

Container Store Group Inc. (TCS)

Container Store Group is a specialty retailer of organizing solutions, custom spaces and in-home organizing services in the U.S. The company operates through two segments: Container Store and Elfa. The Container Store segment consists of retail stores, website and call center (which includes business sales), as well as its in-home services business. The Elfa segment designs and manufactures component-based shelving and drawer systems and made-to-measure sliding doors.

Container Store Group noted that its first-quarter 2023 performance reflects the ongoing challenging macroeconomic environment. Consolidated net sales were $207.1 million, down 21.1%, compared to the first quarter of fiscal 2022. The company reported a net loss of $11.8 million, or a loss of $0.24 per share, compared to net income of $10.5 million, or $0.21 per diluted share, in the prior-year quarter.

It is the policy of the Model Shadow Stock Portfolio to delete a stock once its trailing 12-month adjusted earnings go negative and the company reports a quarterly loss in a subsequent quarter while trailing earnings are still negative.

Container Store Group is being removed from the portfolio due to the Model Shadow Stock Portfolio’s negative earnings rule. Container Store Group was added to the Model Shadow Stock Portfolio on March 8, 2018, at a price of $4.82 per share. It was removed on September 14, 2023, at $2.28 per share, for a loss of 52.7%.

Strattec Security Corp. (STRT)

Strattec Security designs, develops, manufactures and markets automotive access control products primarily to North American customers. The company’s products include mechanical locks and keys, electronically enhanced locks and keys, passive entry passive start systems, steering column and instrument panel ignition lock housings, latches, power sliding side door systems, power tailgate systems, power lift gate systems, power deck lid systems, door handles and related products.

Strattec Security noted that despite higher net sales in fourth-quarter 2023, operating profit results were lower than the prior-year quarter due to higher manufacturing input costs and a stronger Mexican peso against the U.S. dollar. This was partially offset by lower engineering costs associated with a customer reimbursement of engineering development costs. Net sales were $132.2 million, compared to $123.1 million in the prior-year quarter. The company reported a net loss of $2.7 million, compared to net income of $384,000 in the prior-year quarter. It reported a diluted loss of $0.69 per share, compared to diluted earnings per share of $0.10 in the prior-year quarter.

It is the policy of the Model Shadow Stock Portfolio to remove a stock once its trailing 12-month adjusted earnings go negative and the company reports a quarterly loss in a subsequent quarter while trailing earnings are still negative.

Strattec Security is being removed from the portfolio due to the Model Shadow Stock Portfolio’s negative earnings rule. Strattec Security was added to the Model Shadow Stock Portfolio on August 31, 2017, at a price of $31.66 per share. It was deleted on September 14, 2023, at $24.00 per share, for a loss of 24.2%.

VOXX International Corp. (VOXX)

VOXX International is an international manufacturer and distributor in the automotive electronics, consumer electronics and biometrics industries. The company has a portfolio of approximately 35 brands and operates through three segments: automotive electronics, consumer electronics and biometrics. The automotive electronics segment designs, manufactures, distributes and markets rear-seat entertainment devices, remote start systems, automotive security products and devices. The consumer electronics segment designs, manufactures, distributes and markets home theater systems, premium loudspeakers, outdoor speakers, A/V receivers, streaming music systems, cinema speakers, etc. Its biometrics segment designs, markets and distributes iris identification and biometric security related products.

Net sales in first-quarter 2024 were $111.9 million, compared to $128.7 million year over year, a decrease of $16.8 million, or 13.1%. VOXX International reported an operating loss of $11.4 million, compared to an operating loss of $6.7 million in the prior-year quarter. The company noted that its primary near-term obstacle is the global economy as it continues to impact consumer spending. The global retail environment in particular is tough as it has seen the ongoing consumer pivot from spending on durable goods to more travel and luxury goods.

VOXX International is being removed from the portfolio due to the Model Shadow Stock Portfolio’s negative earnings rule. VOXX International was added to the Model Shadow Stock Portfolio on September 9, 2021, at a price of $10.50 per share. It was deleted on September 14, 2023, at $8.10 per share, for a loss of 22.8%.

Quarterly Additions

As of September 13, 27 stocks met the initial selection criteria for the Model Shadow Stock Portfolio. This is up from 23 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.

Eight stocks already in the Model Shadow Stock Portfolio passed the initial criteria at the time of the review: Bassett Furniture Industries Inc. (BSET), Fonar Corp. (FONR), Friedman Industries Inc. (FRD), Hurco Companies Inc. (HURC), Key Tronic Corp. (KTCC), Mistras Group Inc. (MG), NACCO Industries Inc. (NC) and Pangaea Logistics Solutions Ltd. (PANL).

The remaining 19 stocks were examined to ensure adequate liquidity, timely financial filings and appropriate industry and foreign considerations. Four securities were eliminated from consideration because they were master limited partnerships, leasing operations or foreign operations. Five 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. One stock was excluded because its share class did not include any voting rights.

The Shadow Stock Portfolio Rules on AAII.com provide guidance on factors to consider when selecting stocks for your portfolio.

Price momentum was used as the primary tie breaker among qualifying stocks. The remaining stocks were ranked using a 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 the three deletions and the existing cash position of the Model Shadow Stock Portfolio, there were enough funds to take a position in two companies at roughly the average position size for the existing holdings in the tracking portfolio.

Natural Gas Services Group, Inc. (NGS)

Natural Gas Services is a provider of natural gas compression equipment and services to the energy industry. The company manufactures, fabricates, rents, sells and maintains natural gas compressors and flare systems for oil and natural gas production and plant facilities. It also designs, fabricates, sells, installs and services flat stacks and related ignition and control devices for onshore and offshore incineration of gas compounds, such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum gases. In addition, it provides service and maintenance on compressors in its fleet and to third parties. It also performs engine and compressor overhauls.

Natural Gas Services has a book value per share of $18.84 as of June 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $16.96 per share ($18.84 × 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 $18.84 per share. To calculate the maximum purchase price based on the maximum desired price-to-book ratio, multiply the current book value per share ($18.84 for Natural Gas Services) 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).

Park Ohio Holdings Corp. (PKOH)

Park Ohio Holdings provides customers with a supply chain management outsourcing service, capital equipment used on production lines and manufactured components used to assemble their products. The company operates through three segments: supply technologies, assembly components and engineered products.

Its supply technologies segment provides its customers with total supply management, a proactive solutions approach that manages all aspects of supplying production parts and materials to its customers’ manufacturing floors, from strategic planning to program implementation. Its assembly components segment includes extruded and molded rubber, as well as thermoplastic products, fuel filler assemblies and gasoline direct injection systems. Its engineered products segment designs and manufactures a range of engineered products, including induction heating and melting systems, pipe threading systems and forged and machined products.

Park Ohio Holdings has a book value per share of $22.51 as of June 30. If you wish to stay within the 0.90 price-to-book-value maximum, you should pay no more than $20.26 per share ($22.51 × 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 $22.51 per share.

Next Portfolio Review

The next quarterly review of the Model Shadow Stock Portfolio will take place following the end of November 2023. 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).

Performance Update

A continued climate of high interest rates and concerns over a potential recession helped to fuel a stock sell-off in August. Large-cap and growth stocks held up better in August than the broad market. The Model Shadow Stock Portfolio lost 8.0% during August 2023 and is now up 13.6% for the year. The S&P 500 index, as measured by the performance of the Vanguard 500 Index fund (VFINX), lost 1.6% during August and is up 18.6% for the first eight months of the year. The Vanguard Small Cap Index fund (NAESX) is up 10.3% for the year after shedding 3.7% in August. The DFA U.S. Micro Cap fund (DFSCX) lost 3.9% during August and is up 8.4% for the year.

In the large-cap segment, growth stocks were down 0.6% during August and are now up 24.2% year to date for 2023. Large-cap value stocks were down 2.7% during August and are now up 12.8% year to date.

In the mid-cap segment, growth stocks are up 12.2% for the year, after losing 2.1% during August. Mid-cap value stocks are up 7.7% for the year, after losing 3.8% during the month.

Small-cap growth stocks are up 8.6% year to date, while small-cap value stocks are up 5.9%. Small-cap growth stocks lost 3.4% during August, while small-cap value stocks lost 4.9% during the month.

The energy sector was the strongest-performing group during August, while utilities were generally the weakest. Energy prices have been moving up, giving a boost to that sector but making inflation stickier and helping to drive up interest rates. Utility stocks normally trade with the highest dividend yields and their stock prices tend to move down when interest rates move up.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 13.7% versus the Vanguard 500 Index fund’s gain of 9.9% per year on average over the same period. Over the same period, the Vanguard Small Cap Index fund has an average annual gain of 9.7%.

Model Shadow Stock Portfolio News

Hooker Furnishings Corporation (HOFT)

(09/08/2023) Hooker Furnishings reported second-quarter 2024 earnings per share of $0.07, missing the I/B/E/S consensus estimate of $0.26 per share. Total revenue decreased 36.0% from the prior-year quarter to $97.81 million. This decrease was driven by industrywide decreased demand for home furnishings, and the planned exits of unprofitable operations within the Home Meridian segment. Consolidated net income for the quarter was $785,000, down from $5.5 million during the prior-year quarter.

CEO and director Jeremy Hoff reflected upon the quarter, starting by discussing the team’s efforts to strengthen the company’s balance sheet, reduce overhead and costs, and execute growth initiatives in a difficult business climate. He stated that the softer demand seen in the home furnishing industry is likely driven by “retailers continuing to sell through over-inventoried positions and a short-term glut of heavily discounted home furnishings in the market.”

Key Tronic Corporation (KTCC)

(08/16/2023) Key Tronic announced fourth-quarter 2023 earnings of $0.10 per share, up from $0.09 per share in the same period last year. Full-year 2023 earnings per share totaled $0.48, up from $0.31 per share in full-year 2022. Total revenue for the fourth quarter reached $162.6 million, marking a 29% increase compared to the same period in the previous fiscal year. Net income for the quarter rose 9% from the prior-year quarter, reaching $1.1 million.

Looking ahead to first-quarter 2024, Key Tronic anticipates revenue to range between $140 million and $150 million. Earnings per diluted share are expected to fall within the range of $0.05 to $0.15 for fiscal 2024.

Kimball Electronics, Inc. (KE)

(08/16/2023) Kimball Electronics announced fourth-quarter 2023 adjusted earnings per share of $0.76, beating the I/B/E/S consensus estimate by 12.1%. This was a 62% increase from the same period of 2022. Net sales for the fourth quarter of $496.1 million represented an impressive 33% surge compared to the prior-year quarter. Operating income was $31.4 million, marking a substantial 42% increase from one year ago. Net income reached $19.2 million, up 64% from the previous year.

Looking forward, the company anticipates net sales to fall within the range of $1.90 billion to $1.95 billion for full-year 2024, reflecting a year-over-year increase of 4% to 7%. Additionally, operating income is expected to be in the range of 4.7% to 5.2% of net sales.

Lakeland Industries, Inc. (LAKE)

(09/06/2023) Lakeland Industries reported second-quarter diluted earnings per share of $0.32, beating the I/B/E/S consensus estimate of $0.225 per share by 42.2%. Net sales for the quarter totaled $33.1 million, an increase of 17.3% from the prior-year quarter. Domestic sales accounted for $11.9 million or 42% of the total, and international sales accounted for $16.3 million or 58% for the second quarter. Operating profits were $14.2 million, an increase of 22.4%, from one year ago. Net income of $2.5 million increased 383.9% from the prior-year quarter. Gross profit was $14.2 million, an increase of 22.4% from the prior-year quarter.

Additionally, Lakeland Industries repurchased approximately $0.1 million worth of common stock under its stock repurchase program. On July 31, 2023, approximately $5.0 million was available to the company for the repurchase of its outstanding common stock.

Titan Machinery Inc. (TITN)

(08/31/2023) Titan Machinery reported second-quarter 2023 adjusted earnings per share of $1.38, beating the I/B/E/S consensus estimate of $1.17 per share by 18.4%. Net sales totaled $642.6 million for the second quarter of 2023, growing 25.6% year over year. Net income for the quarter was $31.3 million, up 22.4% and 22.6% year over year, respectively, from net income of $25.0 million and $1.10 per share.

CEO and chairman David Meyer commented, “We posted another quarter of strong results, reflecting double-digit same-store revenue growth across all three of our reporting segments. This growth was also balanced across equipment, parts and service—each of which performed well and delivered solid gross margins, which combined for a consolidated pretax margin of 6.5% and diluted earnings per share of $1.38. We remain encouraged by the ongoing demand we are seeing in our business and are working hard to get customers their equipment as OEM production and delivery schedules allow.”