Last week, I wrote an article about Robert Olstein, the famed value investor, and his predilection for studying the shareholder letters of CEOs in their quarterly and annual reports, looking for “heat” or “trigger” items. Those items, according to Olstein, may provide either a warning for an upcoming disaster not previously noticed or a potential catalyst for unleashing cash flows even higher. This prompted me to dig further into his methodology for choosing stocks and had me reading from several sources, including those from his own website.
Ever mindful of his disastrous year in 2008 in which his fund was down approximately 43%, he has since been resolute and unwavering in his quest for choosing only the best of stocks as he continues his detailed financial or forensic analysis of each company. His performance clearly shows that it has paid off and he remains one of the top value investors in the game.
Olstein was quoted in 2001 saying that both Cisco (CSCO) and General Electric (GE), while both great companies, showed serious flaws that prevented him from buying the stocks. Cisco had shown serious problems with its receivables rising, and he commented that he could not purchase the stock until it went down to at least $31. He currently owns approximately 550,000 shares at an average price of $18.
General Electric, which had hit a high, was beginning to tumble. Olstein commented that it would look like a good purchase at $30. While not normally an investor that confronts management, he did not shy away from his position in GE. As for its balance sheet, he points out that future years would be required to make up for the low numbers. He also concludes that the potential for pension issues would dearly cost the earnings reports coming due. GE proclaimed that its accounting was above reproach and GE spokesman David Frail rejected Olstein’s claims, proclaiming that there were not accounting issues.
History is a great teacher, proving Olstein to be correct. And he now owns approximately 353,000 shares at an average cost of $18. Robert Olstein preaches patience and nothing could paint a clearer picture of a patient investor that is focused and predetermined the range to buy each equity and waited for the right pitch. This is the type of investing all investors need to be emulating at all times, especially in the uncertain times of today.
“The most important attribute of a value investor is patience.” — Robert A. Olstein
From his website, Olstein has shared the following methodology which is worth of study:
Note both quantitative and qualitative factors, his emphasis on “economic reality,” the capability of management and its emphasis on discounted cash flow, which apparently is a proprietary method which is not shown for determining intrinsic value and the disclosure and method of managements accounting disclosure. This is where Olstein is at his best.
Olstein is not shy regarding corporate staff and clarifies that it is a waste of time to interview management. Wanting to find managers that do what they promise in their shareholder letters is more important than the cheerleading most are inclined to perform. Per Olstein, “Why should I talk to the ministers of propaganda?” He’s always interested in finding out how honest management is in discussing the economic headwinds that they are facing rather than ignoring the issues. He searches for how they intend to withstand or mitigate the problems. Ignoring them is a red flag to Olstein.
He emphasizes that one of the major issues in stock evaluation is the disproportion or disparity between the earnings reports that come out versus excess cash flow or free cash flows. Olstein preaches to watch company treatment of capital expenditures. He points out that sometimes the company may choose to take smaller depreciation to pump up the earnings or possibly take more in a particular year which may shrink the cash flow. Bottom line: It’s up to the investor to take the time “to determine the economic realism of management’s assumptions," legal or not. He abhors consistent gaps between capital spending and depreciation.
“Excess cash flow is the lifeblood of a business and is the primary determinant of a company’s private market value. Companies that generate excess cash flow have the potential to enhance shareholder(s) by increasing dividend payments, repurchasing company shares, reducing outstanding debt, engaging in strategic acquisitions, or withstanding economic downturns without adopting harmful short-term strategies.” — Robert Olstein
Not shying away from the issue of money stashed overseas by large companies, Olstein recently proffered his own advice on how companies should best deal with the repatriation of it to the U.S. He simply states that they should bring it back. He argues that these companies will receive a tax credit for the foreign taxes paid and he has estimated that these companies will pay an effective tax rate of approximately 30% on the repatriated money. All else being equal, the money brought home could be used for share repurchasing which he believes will increase prices to between the 20% to 30% range. If cash is king, he argues that it does shareholders no good and should be brought home.
He highlights many other issues on which investors should concentrate their effort when studying stocks, including:
Serial acquisitions and determination of the true value of each purchase.
Closely keeping tabs on all ratios, especially debt and return on equity, which project whether the company will be able to withstand any future economic headwinds.
Account receivables rising faster than sales or revenue.
Inventory rising faster than revenue.
The divergence between earnings and free cash flow.
Check the footnotes — all of them. However, he does emphasize that companies with improved earnings should be paying more in taxes, and he pays close attention to that footnote on taxes looking for any discrepancies.
A lot of investors have experienced the price of a stock continuing to plummet after the original purchase and Olstein is no exception, but he remains a patient investor willing to add to his position when convinced of the potential. Fellow great investor Martin Whitman retorted once, “If you want to make a killing, buy what Olstein buys, but first wait three years.”
Disclosure: No positions