08 Sep 2010 Olstein Funds - Q2 2010 Commentary
The current attitude reminds me of the negative psychology that persisted in late 1974. Throughout 1974, pessimism dominated investor thoughts and headlines as a severe and prolonged 18-month bear market dragged on and on. With 20/20 hindsight, the final months of 1974 represented a major opportunity to invest in a portfolio of undervalued stocks as the market was going through a bottoming process leading to an eventual upturn in 1975. We believe equities may offer a more compelling investment opportunity for investors today than in 1974. While P/E ratios in 1974 fell to lows of approximately 7 times earnings compared to today’s level of 10 times forward earnings, back in 1974 investors had a viable alternative to equities as 10-year U.S. Treasuries were yielding close to 8%. In today’s environment, however, investments in 10-year U.S. Treasuries are yielding less than 3% and may also be vulnerable to capital losses if the economy strengthens and interest rates rise.

In addition to low P/E ratios, one of the most important factors influencing our outlook for equities over the next 18 to 24 months is the number of high quality companies that fall within our current cash flow yield target of 8% to 10% or greater. With almost $3 trillion currently sitting in money market accounts earning almost zero interest, and at least that same amount, we estimate, in 2-year or shorter duration Treasury securities earning less than 1%, investors should eventually realize that despite negative economic news, investments in companies with cash flow yields of 10% represent an attractive alternative to bonds.

Although overall market returns may be in low single digits or flat for the foreseeable future, prices of many companies have been driven down to levels that we believe offer attractive returns even in a low growth economy. In this regard we believe that the best way to identify superior investment opportunities in an uncertain market is to focus on a company’s ability to generate sustainable free cash flow.

For us, one of the most important metrics for identifying companies that can generate sustainable free cash flow is free cash flow yield. In simple terms free cash flow yield is a company’s total free cash flow divided by its market capitalization (or its free cash flow per share divided by its price per share). More importantly, if an investor believes as we do that a company’s free cash flow is the primary determinant of its value as an ongoing enterprise then free cash flow yield provides a practical starting point to estimate expected future returns. We believe that a company with a free cash flow yield well above the risk-free rate of return (three-year and five-year U.S. Treasuries are currently providing yields of 0.75% and 1.50%, respectively; Source: Bloomberg, 8/6/2010), combined with a demonstrated ability either to reinvest excess cash at higher rates of return than the risk free rate or to use that cash to enhance shareholder value, should prove to be a superior, high-quality investment over time.

We expect that over the next year interest rates should start to firm, company earnings should continue to move to the upside with the usual bumps along the way and the economic outlook should continue to improve. Individual stock prices should ebb and flow as quarterly earnings are reported in reaction to the absurd quarterly earnings hit and miss game played by Wall Street analysts which we believe has little to do with long-term valuations. Remember, when companies’ earnings disappoint analysts it is usually the analysts who are wrong, not the companies as it is the analysts estimates. Once investors have concrete evidence that the economic environment has changed, investors will slowly return to equity markets. We believe that as investors re-enter the market, companies that generate sustainable free cash flow and use that cash to benefit shareholders, should capture the attention of equity investors and lead overall market performance.

01 Jun 2010 Olstein - Q1 2010 Commentary
As the pessimism from the recent recession continues to dominate the investment landscape, investors are slow to adapt to change and believe their most recent experience will repeat forever and act accordingly. Before adapting their investment decisions, investors need concrete and indisputable evidence that the environment has changed Investors are slow to eliminate their most recent experience.

Investors are afraid to commit funds withdrawn from the market during the most recent crash (most of the funds were withdrawn late in the downturn at significant losses) fearing a repeat performance even though there is tangible evidence that business has begun to turn around. Investors should always remember that the market is a discounting mechanism and, as such, is anticipating the future not reacting to what is.

We are buying companies that we believe have a sustainable competitive advantage, discernible balance sheet strength, a management team that emphasizes decisions based on cost of capital calculations and deploys free cash flow to create shareholder value. We believe companies with the aforementioned characteristics are poised to eliminate their valuation gaps created by the recent bear market as the economic recovery eventually accelerates.

27 Apr 2010 Video: Bruce Greenwald, Robert Olstein, David Winters and Thomas Russo on value investing
Bruce Greenwald, professor of finance and asset management at Columbia Business School, Robert Olstein, chairman of Olstein Capital Management LP, Thomas Russo, a partner at Gardner Russo & Gardner, and David Winters, chief executive officer of Wintergreen Advisers LLC, participate in a panel discussion on value investing. Bloomberg's Betty Liu moderates the event which took place at Columbia Business School in New York...

05 Mar 2010 Olstein Funds - Q4 2009 Commentary
As stability and/or early signs of recovery unfolded in global markets during the second half of 2009, institutional equity investors began to adopt cautious optimism by spending some of their cash, which resulted in significantly improved market performance off the low of March 9, 2009. Yet despite this rebound, many investors (especially individuals) remain nervous about the prospect of slower economic growth, and continue hoarding their money in short-term U.S. Treasuries and money market funds leading the general public and press to conclude that there is a damper on future equity market returns. Questions about the strength and pace of economic recovery are likely to dominate the first half of 2010 as investors seek objective proof that we have permanently turned the corner before committing safe short-term funds to equities driving positive market returns.

Like many investors, we have seen two schools of thought dominate most of the 2010 market outlook discussion. The more constrained school of thought, often referred to as the “new normal”, predicts a prolonged period of subdued single-digit annual returns for U.S. equity markets, rooted in a slow economic recovery constrained by historically high levels of unemployment. Conversely, there is a more optimistic school of thought that predicts a faster and more vigorous recovery driven, in large part, by pent-up demand, depleted inventories and over-extended replacement cycles. While we recognize merit in both of these scenarios, we believe a singular emphasis on either argument fails to provide the necessary focus for developing an optimal portfolio strategy in 2010.

While both of these schools of thought rely heavily on the presence or absence of bullish sentiment to drive or restrain overall market growth, we continue to focus on how individual companies have adapted their expectations and operations to unfavorable market conditions and how they have managed their assets during the downturn. This information helps us evaluate whether a company has increased the probability of delivering future earnings to investors. It is our opinion that companies that have discernible balance sheet strength, operating flexibility, a sustainable competitive advantage and management teams who weigh cost of capital versus potential returns on investment before making decisions, have a higher probability of outperforming when the economic recovery takes hold. Another important factor we look for in potential stock market leading companies is a history of developing free cash flow to create shareholder value.

While pundits and forecasters may argue about the speed and strength of economic recovery in the United States in 2010, we believe two other factors are likely to take center stage this year. First, it is our opinion that portfolios emphasizing companies having material non-U.S. revenue sources have a higher probability of growing earnings faster than pure domestic companies. Second, we believe that valuations in 2010 and future years will be based on demonstrable free cash flow, rather than unrealistic expectations of future growth prospects.

Our prior letters described that immediately following the collapse of Lehman Brothers in September 2008, we drastically reshaped the Fund’s portfolio and were able to buy at favorable prices many core positions in high quality, strongly capitalized companies (e.g. Microsoft, Coca Cola, Kimberly Clark, Intel, etc.) with wide moat business models and long histories of success and integrity. At the time we acquired these high quality companies with extremely liquid balance sheets, they were selling at unprecedented low multiples of free cash flow, and in certain cases, were selling at prices that were lower than a decade prior.

We not only believe in the defensive posture of such well-capitalized companies, but also believe that their extensive global operations should provide an additional edge to future earnings growth going forward. Our forecast is that non-U.S. economic growth may exceed U.S. GDP growth in 2010 and future years. As of December 31, 2009, twenty four companies, representing 30% of the Fund’s total equity investments, have a market capitalization greater than $25 billion. For these twenty four companies, non-U.S. revenues range from 10% to 94% of total revenues with a collective average of 52% of company revenues derived from non-U.S. operations. For companies with extensive global operations, corporate profit growth could well exceed U.S. GDP growth, especially if significant earnings come from economies that have weathered the downturn well and are likely to bounce back stronger and faster than the U.S. economy.

As previously stated, in addition to the growth potential of mega- and large-cap U.S. companies with global operations, we also believe that as the economic recovery unfolds in 2010, a company’s ability to deliver sustainable free cash flow will drive its stock price instead of speculation about its growth prospects. While P/E multiple expansion accounted for a significant portion of equity returns during the last bull market, we believe that dividends and stable free cash flow are likely to account for the bulk of stock market returns for the foreseeable future. We expect strong, well-run companies will experience more modest earnings growth than in the past. We expect stock market leaders to experience growth rates of 3% to 5% per year versus the 10% to 15% growth rates that investors sought during the previous bull markets. Although lower growth rates going forward may reduce past price earnings ratios, we believe companies that can grow yearly cash flow at 3% to 5% growth rates are going to be the market leaders. The growth companies going forward are going to sell at lower multiples than the 20+ multiples experienced in recent bull markets as a result of the lower growth rates we are predicting. However, once the market adjusts and sorts out the new leaders, price earnings ratios of these new low growth companies should expand from the current 15 times multiples to the 17-18 range. The sector bets of the 2003-2007 bull market are going to be replaced by sustainable low growth free cash flow companies with solid balance sheets. Investors who pay fully-valued prices for established companies expecting double digit growth rates could be disappointed in their future returns.

As John Bogle commented in an op-ed that recently appeared in The Wall Street Journal (January 19, 2010), over the past thirty years “the folly of short-term speculation has replaced the wisdom of long-term investing as the star of capitalism. A ‘rent-a-stock’ system has replaced the earlier ‘own-a-stock’ system. The result – the momentary illusion of the price of a stock took center stage, replacing the enduring reality of the company’s intrinsic value – the discounted value of its future cash flow.” An important tenet of our investment philosophy is the belief that companies that produce excess cash flow after capital expenditures and working capital needs are the companies that build meaningful shareholder value over time by either delivering that free cash flow to investors in the form of dividends or by intelligently re-investing free cash flow into the business to increase the value of shareholder’s equity. We believe that when the reality of the 2010 economic recovery takes hold, investors should place a greater emphasis on analyzing how a company’s operations generate sustainable free cash flow; and determining how much of that free cash flow is, or might be, available to investors.

02 Feb 2010 Why All Earnings Are Not Equal
Some of the widest gulfs between earnings and cash flows, Mr. Olstein said, are showing up the ways companies account for capital ex- penditures. To ensure growth, companies invest in things like new facilities or additional equipment. As time goes on, plants and equipment lose value — the way a car does the moment you drive it away from the dealer — and companies are allowed to write off a portion of these values each year based on management estimates of how long they will generate revenue.

The write-offs are known as depreciation, and the more a company chooses to write off, the greater its earnings are reduced. So managers interested in plumping their profits may depreciate less than they otherwise would or should. Conversely, heavy depreciation amounts can make earnings appear more depressed than the company’s
cash flows indicate.

“It’s an investor’s job to determine the economic realism of management’s assumptions,” Mr. Olstein said. “There is nothing illegal here, but maybe their depreciation assumptions are unrealistic.” One way to assess the accuracy of management’s estimates is to compare, over time, how much a company spends on new plant and equipment and how much it deducts in depreciation each year. Some of the discrepancies that emerge can be temporary, caused by the lag time between an initial invest- ment and subsequent write-downs for depreciation.

Companies in a growth phase, for instance, will show greater capital expenditures than depreciation as they increase investments in plant and equipment.

But that should be only temporary. If such discrepancies appear on a company’s books year in and out, then investors might well question the depreciation assumptions. Investors confronted by large disparities should discount those companies’ earnings by the amount of excess capital expenditures. Such an ex- ercise reveals how much free cash flow is available to stockholders.

Conversely, if depreciation exceeds capital expenditures, Mr. Olstein says that the earnings at these companies are actually better than they appear — and that this shows up in the cash flows.

08 Sep 2009 Olstein Funds - Shareholder Report
We believe that the stock market bottom which was reached on March 9, 2009 following a long market slide that began in the fourth quarter of 2007, should not be breached as there are many signs that the current recession is in the process of bottoming. Yet despite cautious optimism about the economy, we also believe it is going to take several years to get back to the market highs reached in 2007 since we expect the economic turnaround to be measured and slow over the next few years.

The worldwide coordinated stimulus has planted the seeds for an economic turnaround which we expect should begin later in the year. As has happened many times in the past, the market has begun to anticipate an economic turnaround, as reflected in recent market performance. Although market returns going forward should be more subdued than during the 2003-2007 period, we believe the current market offers the potential for high single-digit or low double-digit returns from current levels (based on our future expectations for earnings and interest rates), which compares quite favorably to the alternatives in low-yielding treasury bills and money market accounts. Although the large amounts of fiscal stimulus and budget deficits around the world have also triggered serious inflation fears, we do not believe such concerns are warranted at the present time. The large amounts of excess labor and industrial capacity in combination with wage cuts must recede before we become concerned about future inflation. We do not think inflation is a serious concern over the next two years.

28 May 2009 Olstein Funds market update
It is our belief that current opportunities in equity markets offer a favorable time to begin pursuing these longer-term investment goals. Investors who have recently been burned, or have exited the market, usually express a desire to wait until “markets look better” before re-investing or increasing their commitment to equities. In essence, however, this sentiment reveals a hidden belief that one can “time” the market. We strongly believe the most attempts to time the market regarding “buy” and “sell” decisions interfere with the longterm goals and objectives of equity investing. Attempts to time the stock market require two decisions: when to sell and when to get back in. Unfortunately, most investors get one or both of these decisions wrong and such wrong decisions can lead to compounded errors that result in a pattern of buying closer to market tops and selling near bottoms - a strategy which usually produces disappointing long-term returns. Historically, the majority of market gains have occurred in short-term spurts rather than being evenly spread throughout the year, thus necessitating a consistent percentage allocation to equities in lieu of intervals “in” or “out” of the market. There have been many studies published over the past 40 years demonstrating that the failure to be in the market in just a few of the best days each year can wipe out the long-term objectives of equity investing. These studies indicate why the odds are so poor in attempting to time markets over long periods of time in order to profit there from. During my 43 year career, I have seen many attempts by all kinds of gurus (who have established credibility in the short run by making prescient market calls) to time the markets over extended periods of time based on proprietary formulas which were predicted to produce above average profits for its followers. In my experience, all attempts to time markets with any degree of consistency over long periods of time in order to produce profits, eventually failed. Rather then succumb to the desires of the mass of investors to time markets; we believe it is our mission to find securities to buy that we believe have the ability to either outperform the market or at the very least capture the positive market returns that have been generated over long periods of time. It is significant to note that these positive stock market returns have been generated despite the intermittent bear markets and corrections that occur from time to time.

11 Feb 2009 Olstein value fund shareholder letter
...many of the sophisticated strategies developed by Wall Street to control short-term volatility, in an attempt to allay investors’ fear of risk, actually subject the investor to additional risks that may be of a greater magnitude than the risks associated with the short-term volatility the investor sought to avoid!

...the current climate, created by abnormal and temporary conditions, and characterized by low stock prices, should result in higher future rates of return. The credit crisis will end and the housing market will stabilize, but no one will ring the bell to alert investors to these positive developments. The market is a discounting mechanism. While past performance is not necessarily indicative of future results, it is noteworthy that the seeds of past periods of relative outperformance were sown during volatile and extremely emotional down markets in 1998 and 2002. The bottom of a bear market by definition is the point of collective maximum negative sentiment and activity. We have never figured out a method of predicting a market bottom, but we can say that the negativity at the current juncture is at extreme levels. As value investors, we believe in having a long-term horizon in an environment that is maniacally focused on short-term events...