"Remember When to Get Out"

Robert Olstein of the Olstein Financial Alert Fund says investors who can't pinpoint the bailout moment should get a good adviser

Think about losing before you think about winning -- that's part of the strategy of Robert Olstein, chairman and chief investment officer of the Olstein Financial Alert Fund (OFALX ). There must be something to his attention to possible losses, because through the bear market from the end of 2000 to the end of 2002 his fund gained 7% to 8%.

"There's only two kinds of discipline -- value and overvalue," says Olstein. Growth is just a component of his value strategy: "We will buy growth as long as they're good value," he notes. And another important point to him is selling when a stock reaches its value. Understanding financial statements is the most important part of stock-picking, in his view, and contrary to many managers, he believes that talking to management can be misleading.

His fund's largest holding currently is Tyco (TYC ), followed by Disney (DIS ), Manitowoc (MTW ), Scientific Games (SGMS ), and WMS Industries (WMS ) [formerly Williams Electronics]. One of Olstein's recent acquisitions is Interpublic Group (IPG ), which he sees as undervalued but promising.

These were a few of the points Olstein made in an investing chat presented Apr. 15 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Bob, give us your view of this market -- it can't seem to find a footing of late to resume its climb.


The market is fairly valued based on earnings. It needs to catch up to the actual estimated earnings of the S&P [500]. We think the market is going to trade in a very narrow range to the end of this year, somewhere between 1000 and 1200.

That being said, there's a lot of room to find undervalued securities, but you're going to have to trade them out when they reach their values. You'll have to remember when to get out.

Q: What do you think of earnings reports so far? Are expectations very high?


Basically, the expectations on the part of the investors are too high, yes. The market went up on the expectations, and now they want them to go up on the actuality. That's not going to occur. It has already been discounted into this year, however.

Q: Inflation and rising rates -- what to do?


Rising rates destroy values, but inflation helps earnings. Again, I'm coming back to the same answer. Basically, you have counterbalancing forces on the market now.... We're going to have a fine year, but that doesn't mean back to 1998-99 levels. Most managers will be happy to see 10% returns.

Q: You say there's room to find undervalued stocks -- what are they?


I don't make any picks, but I'll show you some of the stocks in our fund that are undervalued. Interpublic Group (IPG ) is one -- we acquired it recently. Here's a company that has fallen by the wayside because they went away from their basic business, went into motor sports, and had some accounting problems. Pessimism is in the stock, but we think the stock is worth somewhere in the 20s, but it's only at 15 and change. We're long-term players.

Q: What are the top holdings of the Olstein Financial Alert Fund (OFALX )?


Tyco (Tyco's our largest, actually), Disney, Manitowoc, Scientific Games, WMS Industries [formerly Williams Electronics], American Greetings (AM ), Hasbro (HAS ), Payless Shoesource (PSS ), and Tupperware (TUP ).

Q: You advised getting out when a stock reaches its value. How does an investor determine that point?


If they don't have the ability to determine that point, in terms of understanding excess cash flow, I would recommend they get a good adviser. I don't practice dentistry -- why do some investors go without an adviser? Find an expert with a good fund.

Q: Are you in agreement with almost all of the guests on CNBC who are recommending divesting financials?


I agree with very few of the guests on CNBC about anything. To make a general statement like that shows me how ridiculous that is -- all financials are not overvalued -- some of them are. We have good investments in financials that have done well and will continue to do well, but not all financials. All these guests who dispense such advice with 100% certainty -- are they trillionaires?

Q: Among the financials, what do you own? And do you see other values there?


I'm only going to talk about what we own. We own Merrill Lynch (MER ), Morgan Stanley (MDW ), and Comerica (CMA ).

Q: Are you an active shareholder? Didn't you write the CEO of J.C. Penney (JCP ) about selling Eckerd?


When you say an active shareholder, I'm a big shareholder in the fund. I write CEOs all the time. I've written [Walt Disney CEO Michael] Eisner, Penney, the CEO of McDonald's (MCD ). So yes, I'm active, but if they don't react to me, I sell them -- I don't go and fight with them.

Q: What's your assessment of the Comcast/Disney takeover battle?


I believe Disney should turn them down, but I believe Comcast (CMCSK ) should try to take them over. I believe Comcast would be wise not to listen to their shareholders and offer $35 in Comcast stock. I think [Comcast CEO Brian] Roberts, who is very short-term-oriented and worries about shareholders rebelling, is making a mistake and should just do it. Comcast could definitely use this -- it will make it a stronger company.

Q: Do you think the Fed will raise rates at its Apr. 22 meeting?


I'm willing to guess not, but somewhere along the line they will. I don't know about individual meetings, but it will happen somewhere along the line. It's still probably a little premature right now. I'd say probably sometime in the next year. But as to which meeting, I'm not about to guess.

Q: In implementing your value strategy, how much do you tilt toward growth?


To me, there's only two kinds of discipline -- value and overvalue. We will buy growth as long as they're good value. I think growth is a component of value -- you cannot separate the disciplines.

So we don't tilt any way -- we go where we can find attractive valuations. If it's in growth, we go growth. If it's in cyclicals, we go cyclicals. I'm a big negative fan of the style box. It's a popular idea but doesn't mean anything.

Q: Are you seeing any values among the tech stocks?


Not as much as we were a year ago. We still own some that we bought, but I'm not seeing a tremendous amount of undervaluation in the tech area. We continue to own 3Com (COMS ), Fairchild Semiconductor (FCS ), Technitrol (TNI ) -- we don't have a lot of technology.

Q: Do the Iraq situation and our Presidential election make you cautious about owning anything in particular?


No. All the election will mean is more volatility. I'd like to make a general comment that people should not be concerned about predicting the market and should be more concerned about having the right stocks, being diversified away from the market with some fixed income to protect them from said volatility. I've yet to find that person, me included, who can predict where the market is going with any degree of regularity, and to profit therefrom.

Q: How do you calculate the value of a stock?


Discounted free-cash-flow yield compared to the five-year U.S. Treasury rate.

Q: Where do you get your investment ideas? Is it from dissecting the financials only?


Yes. We do some speed reading first, but we only make our decisions from dissecting the financials. We do read all kinds of publications, but we don't talk to management.

Our philosophy is more based on what could we lose, before we think about what we could gain, and we've never had management tell us what we could lose. We believe in a high correlation between long-term performance and error avoidance.

Q: Do you worry about the impact on the market and the economy of the huge deficits and the declining dollar?


I worry about everything! But I'm not a macroeconomic guy -- I try to find the right companies. I'm so paranoid that when I go to a football game, I think they're talking about me in the huddle.

Q: What would you say differentiates your fund from other funds with similar styles?


Our primary attention to think about losing before we think about winning. To not talk to management during our research process or to the Street. We do our own research, and we believe that understanding financial statements is more critical than any other process.

Our penchant for paying attention to the reality of accounting also sets us apart. We actually think that talking to management can be misleading, and our definition of value, which cuts across all disciplines, is also somewhat unique.

Q: With your attention to possible losses, how did you fare during the bear market?


Well, if you define the bear market as March, 2000, ending in March, 2003, an investor in our fund during that time period -- actually, let's take it from the end of calendar year 2000 to the end of 2002 -- our investors made money. We were up about 7% or 8% during that period.

Q: To what extent do you employ technical analysis in your investment decision-making?


We own three ouija boards. We don't use technical analysis.

Q: How should investors factor the possibility of terrorist threats in the U.S. into their portfolios?


It obviously overhangs everything -- it's a big risk in the market today. I hope and pray it doesn't happen -- it would destroy psychology. There's no way to defend against that in a portfolio. I'd go back to my 50/50 idea -- 50% fixed income, 50% equities.

Q: Has the fund sold anything this year? And if so, why?


We've sold plenty, because some of our values we were wrong on. We bought a stock a year ago we thought at the right price, when they were already down -- Safeway (SWY ). The key to investing is, how bad are your losers? If you pay the right price going in, they're not bad. We only lost 5% or 10% of our money there, where others who jumped in earlier lost a lot more.

Q: What was the best and worst investment decision you ever made?


The best right now I'd say was back in 1993-94, when Intel (INTC ) was going along at 10 times earnings, and everyone else was buying Motorola (MOT ). We took a major position in Intel. We sold it in 2000 at its peak.

Worst? Why are you trying to bring up pain? We bought a company by the name of Annuity & Life RE Holding (ANR ), and basically this company had two businesses, one of which was insuring a portfolio of stocks. And we didn't correctly research the vulnerability when the company took a write-off. We bought the stock at 16 -- it was a bottomless pit -- and we sold at 4. Today it's 1. So sometimes even a bad loss is better than holding it all the way.

Edited by Jack Dierdorff

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