Contrarian with a Cause
"Stocks that are under siege" are what Robert Olstein seeks for the Olstein Financial Alert Fund (OFALX ), where he serves as chairman and chief investment officer. "We're in there buying when everyone else is selling," Olstein says.
But Olstein points out that his fund has very strict disciplines for buying and selling, based not just on value but also on a company's cash flow and accounting. The most critical point, he says, is comparing free cash flow with reported earnings.
This strategy has brought the fund a 16.5% average annual return over 10 years, after all fees, Olstein reports. Its only down year was 2002, off 19%. In 2000, the year the tech bubble burst, the fund was up 12%, and in 2001, up 17%. Currently, its top five holdings are American Greetings (AM ), Interpublic (IPG ), Williams Cos. (WMB ), Tyco (TYC ), and Tribune (TRB ).
Olstein discussed his philosophy on stocks in an investing chat presented Apr. 21 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at keyword: BW Talk.
Q: Bob, this market is setting records in both directions, down and up. What's your prognosis for the direction we'll be going in? A:
Q: Bob, this market is setting records in both directions, down and up. What's your prognosis for the direction we'll be going in?
A:We are market-neutral people -- we don't get involved in philosophical issues -- but I will tell you we're fully invested for the first time in a long time. We're finding values out there. You're going to have to pay attention to values out there, pay attention to cash flow and accounting.
We have very strict buy and sell disciplines. We don't know what the masses of investors are going to do, so our best guess is that we're in a trading market here for the next year or two.
Q: What are you buying now? A:
Q: What are you buying now?
A:Stocks that are under siege -- no different from anything we've ever done before. We've established positions in Tribune (TRB ), which has had circulation issues. But cash flow is solid. Pier 1 Imports (PIR ) is very undervalued, even though they've had poor same-store sales, but they do have a couple of dollars a share in cash on their balance sheet, and eventually that free cash earnings power should stimulate them.
Now, we are wrong on one out of every three stocks we buy, but if we're right, we do get around 50% appreciation over two years.
Q: What are your favorite energy stocks? A
Q: What are your favorite energy stocks?
A: The only energy stock we have is Williams (WMB ), which is really in the gas and pipeline industry.
Q: Bob, can you update us on how your fund has been performing? A:
Q: Bob, can you update us on how your fund has been performing?
A:Our fund over the last 10 years has had a 16.5% return after all fees, through December. This year we're down, but that's because we're in there buying when everyone else is selling. That's the way we buy stocks -- we buy those that are on the way down, that have some misperception or negativity around them. That's how we find value, and that's how we play the market.
Q: You look behind the numbers -- what numbers do you think are most important now? Or are they always the same? A:
Q: You look behind the numbers -- what numbers do you think are most important now? Or are they always the same?
A:They're always the same. The most important number you should look at is free cash flow, which is earnings plus depreciation, minus capital expenditures, plus or minus working capital needs. Basically, the most critical thing is comparing free cash flow to the reported earnings. Eventually, these numbers all need to match up and resolve, or you've got some accounting issues.
Q: Bob, are you selling anything? Or shorting any positions? A:
Q: Bob, are you selling anything? Or shorting any positions?
A:We're short two stocks in our portfolio, Computer Sciences (CSC ) [whose accounting is not in accord with economic reality]. Their earning power is worth about $30, in our opinion. Fleetwood (FLE ) is another -- we believe their value is about 50% lower than it is. They have some earnings issues and some real inventory and receivables issues. They're worth somewhere in the $5 to $6 range.
Q: Are there any accounting reforms you favor? A: Q: Beyond cash flow, is there anything else that we should keep an eye on during this earnings season? A:
Q: Are there any accounting reforms you favor?
A:Yeah. I'd like to stop the nonrecurring write-offs. I believe that anything done within 90 days of an acquisition should be taken in the operating line, and maybe that would stop [companies] from making ridiculous acquisitions and writing costs off as nonrecurring.
Q: Beyond cash flow, is there anything else that we should keep an eye on during this earnings season?
A:Yeah. Receivables growing faster than sales, inventories growing faster than sales, accrued expenses on the balance sheets going down. Look at other assets to see that they're not moving up materially, and compare cash flow to actual earnings. Don't worry about a penny or two, though. Stop getting involved in quarterly numbers, and start thinking about long-term value.
Q: You've been an active shareholder in the past [as with J.C. Penney (JCP )] -- are you actively pursuing changes at any of the companies your fund owns? A:
Q: You've been an active shareholder in the past [as with J.C. Penney (JCP )] -- are you actively pursuing changes at any of the companies your fund owns?
A:When you say active, we've written letters to management -- McDonald's (MCD ), Penney, etc. -- and made suggestions about changes. I'm scanning the portfolio here -- I really can't think of anybody we own that's really bothering us right now. I'd like to see RadioShack (RSH ) cut back their capital expenditures and put their free cash back into dividends or buying back shares. They're trying to be a growth company, but we think they're more valuable as a nongrowth company.
Q: What do you think of index investing these days? A:
Q: What do you think of index investing these days?
A:I think it's an idea that has lost its appeal. It's nothing more than a high-momentum growth vehicle and, unfortunately, they seem to be chasing growth after it's over. You'll buy JDS Uniphase (JDSU ) and Yahoo! (YHOO ) at their elevated prices. These index companies have so little return to their investors I don't think they deserve even their low fees. You can't blindly invest anymore -- it just doesn't work.
Q: Are your stocks primarily large-cap? A:
Q: Are your stocks primarily large-cap?
A:Well, we don't pick physicians by their height, and we don't pick companies by their size. We pick them by their value. That being said, we happen to find more value at this point in time in what most people would call a midcap area. But we're not committed to that. We have a sampling of everything.
Q: Tell us why you like Tyco -- are the bad days behind it? A:
Q: Tell us why you like Tyco -- are the bad days behind it?
A:Well, we bought Tyco at $14 a share. We've sold some but still think the stock is good. Our value is $45 a share, and the stock is selling at $32. We'll sell some on its way up, but still own it because we think it's going higher. Given the price we bought it at, it has been one of the biggest gains our fund has ever had.
Q: What have been some of your other success stories? A:
Q: What have been some of your other success stories?
A:Disney (DIS ) -- major success story. McDonald's -- bought a few years ago. Hasbro (HAS ), J.C. Penney -- the latter being one of our biggest successes as well. We bought it as low as $9 a share.
Q: Are you making any plays on higher commodities prices? A:
Q: Are you making any plays on higher commodities prices?
A:Well, higher commodities prices are a fact of life. We're factoring it into our decision-making process. Do we own stocks with commodities exposure? Sure, we own Williams, but we're not directly playing the higher prices. We do indirectly take them into account. We own a steel company, AK Steel Holding (AKS ). We don't play commodities per se, really.
Q: How has the fund ridden the downturn so far this year -- not counting today? A:
Q: How has the fund ridden the downturn so far this year -- not counting today?
A:We're down about in line with the market right now. We've beaten the market by a tremendous percentage in the last nine years, over the S&P. This year we're down 4.8% -- the S&P's down 4.3%. We're early in the year, though, and the fight goes on.
Q: Do you own any tech companies that you're excited about? A:
Q: Do you own any tech companies that you're excited about?
A:We just buy companies that are undervalued. When you get excited, you make bad judgments. We do own some techs. We recently bought Cisco (CSCO ). We own some Lucent (LU ). We were short Lucent many years ago, in the 1960s. We recently bought it at $3 in the last four months. Cisco we bought at $17 and change.
Q: So did you ride out the bursting bubble pretty well -- and was your attention to accounting values a reason for your success? A:
Q: So did you ride out the bursting bubble pretty well -- and was your attention to accounting values a reason for your success?
A:Definitely. When the bubble burst in 2000, the account was up 12%, and in 2001 we were up 17%. In 2002, we were down 19%, and that was our only down year in the fund's existence. So in the three-year bear market, we were up slightly.
Q: What about financial stocks? A:
Q: What about financial stocks?
A:We got loads of those. Nothing stands out in particular, though we've been a long-term holder of Bank of America (BAC ). We own Merrill Lynch (MER ) as well.
Q: Bob, what would you say is the most important event for investors to watch for this year? A:
Q: Bob, what would you say is the most important event for investors to watch for this year?
A:That's a good question. I would say, make sure that the 10-year [Treasury] rate does not go through 5%. If it goes through there, we've discounted a 10-year rate at that level, but not above that. If we do go above that, some of the value is going to start coming down, big time.
Edited by Jack Dierdorff