James Cloonan came up with the term “shadow stock” back in 1983 to help describe a class of stock that possesses several desirable characteristics identified through intensive studies of the stock market.
It had come to light that certain approaches for selecting stocks tend to produce better results and do so over long periods of time. When we first defined Shadow Stocks, the focus was primarily on size and neglect. We looked for the following characteristics:
Relatively small compared to large corporations, but large enough to be developed and exchange-traded.
Relatively neglected. Not well researched by professional analysts as measured by the number of analysts providing estimates and the number of institutional holdings.
Underpriced rather than overpriced securities that highlight inefficiencies in market pricing.
As originally defined, “Shadow Stocks are those whose companies are of a size that permits dramatic growth, those that are not well researched by the professionals and those whose neglect has led to underpricing.”
The rules used to define and capture Shadow Stocks have evolved over time as new research continues to highlight promising techniques individuals can use to select and build stock portfolios. Notably, relative price strength has been introduced to help select Shadow Stock candidates. See page 35 for the current Shadow Stock portfolio rules.
The AAII Model Shadow Stock Portfolio posted a strong gain in May, climbing 8.1%; however, it was not enough to bring the year-to-date return into positive territory. The Model Shadow Stock Portfolio is down 2.5% for the year as of May 31, while the Vanguard 500 Index fund 
(VFINX) is up 1.9%.
Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.5% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.4% per year on average through May 31.
The stocks that currently make up the Model Shadow Stock Portfolio can be viewed here, and the changes made during the quarterly update are listed on the Transaction History page.
After conducting the quarterly review of the Model Shadow Stock Portfolio, AV Homes Inc. (AVHI) is being removed and Universal Stainless & Alloy Products Inc. (USAP) is being added.
AV Homes has been on earnings probation since its fourth-quarter 2017 earnings release on February 22. On April 26, the company reported an adjusted (non-GAAP) loss of $0.10 per share for its fiscal first quarter, expanding its trailing 12-month adjusted loss to $1.04 per share. Because the company went two quarters with trailing adjusted earnings being negative and it reported an adjusted loss for the latest fiscal quarter, AV Homes triggered the portfolio’s earnings sell rule. The stock has been removed from the Model Shadow Stock Portfolio.
With the proceeds from the AV Homes sale and the existing cash position, there were enough funds to take a position in one company at roughly the average position size for the existing holdings in the model portfolio.
Twelve stocks met the initial selection criteria for the Model Shadow Stock Portfolio at the end of May and six are currently held in the Model Shadow Stock Portfolio. Qualifying companies are noted in the Notes column of the Actual Portfolio tab in the Downloadable Spreadsheet. The liquidity requirements and four-week relative strength were used to select Universal Stainless & Alloy Products.
You can follow the Model Shadow Stock Portfolio in the Model Portfolios area. To receive monthly email updates along with alerts to any changes made to the portfolio, please go to www.aaii.com/email.
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