Investment Trends Come and Go, but Value Always Matters
DEAR FELLOW SHAREHOLDERS:
The stock market in calendar year 2020 ended on a positive note as US equity markets continued their dramatic rebound from one of the steepest declines in market history that started in early February 2020 and bottomed in late March 2020. Fueled by an extraordinary scope and speed of fiscal stimulus and the announcement of multiple highly effective vaccines to combat the spread of the COVID-19 virus, U.S. equity markets started rebounding strongly in the second quarter of 2020 with the Dow Jones Industrial Average, S&P 500® Index and NASDAQ Composite reaching all-time closing highs on January 8, 2021.
Although COVID-19 continues to cause some economic distress, in 2021 vaccine distribution programs and government monetary intervention have started to flatten the pandemic curve, restore confidence, and thus reinvigorate some consumer confidence and economic activity. As consumer and investor sentiment finds a surer footing, we believe that equity markets should continue rewarding companies with strong fundamentals that have practiced sound capital management throughout the crisis. By sticking to our discipline of purchasing what we believe are good companies with outstanding businesses, sound balance sheets and generating free cash flow, we have started to realize the benefits of investors finally returning to the ignored value stocks selling at material discounts to our calculations of intrinsic value, which were widened by the recent pandemic. Just 6 short months ago, as investors began to panic in reaction to the uncertainty created by the rapidly spreading worldwide pandemic, massive fear-based liquidation and unprecedented steep and rapid stock market declines created discounts in certain stocks that became difficult for us to ignore. As the panic began to unwind and the market began to rally off of the March lows, the outstanding bargains created by the massive rapid liquidation began to attract investors to companies with liquid balance sheets, realistic accounting practices, and market prices that, in our opinion, defied logic when compared to our assessment of the company’s ability to generate and or grow normalized future free cash flow. As a result of this subtle change in investor behavior the Funds have demonstrated above average performance over the last 6 months. We believe that markets are at the beginning of at least a 3-to-5-year trend in which company fundamentals, free cash flow levels and realistic accounting assumptions become more important to valuing a company than quarterly earnings beats and misses. Of course, there may be some stock market corrections along the way.
Trying to predict overall stock market movements with enough degree of regularity to profit therefrom is akin to attempting to discover the Fountain of Youth which, in our opinion, is a long-term failure process. We intend to stay the course utilized over the past 25 plus years of buying and selling securities based on discounts to our calculation of intrinsic value, after an exhaustive fundamental analysis of a company’s business, management, financial statements, and the quality of its earnings. Although sometimes counter-intuitive, we tend to find our best bargains in down markets and are usually net sellers in up markets as discounts (our investment edge) narrow. There have been many instances of one-time great calls on future markets, but we are not aware of anybody who has made consistently accurate market calls to generate long-term profits therefrom. Our “timing” is based on paying what we believe is the right price when the market is only paying attention to short-term factors that have little to do with long-term values. The portfolios of the Olstein All Cap Value Fund and Olstein Strategic Opportunities Fund consist of companies that we believe have sustainable competitive advantages, discernible balance sheet strength, and management teams that emphasize decisions based on cost of capital calculations and deploy free cash flow to create value. We remain focused on individual companies, their operations, and prospects for maintaining or growing sustainable free cash flow. As long-term value investors, we recognize that companies generating sustainable free cash flow are well positioned to compete profitably during both favorable and challenging economic environments. We are still finding companies that, in our opinion, have the ability to deliver above average long-term (3 to 5 year) appreciation to shareholders.
As has happened many times in the past, above average undervaluation opportunities can be created during periods of market pessimism, when there are temporary problems affecting an industry or company, or during periods of investor concentration on new and exciting industries and companies growing earnings at above average rates and whose stock prices are even growing faster (e.g., currently some of the “FANG” stocks). The meteoric rise in the stock prices of the current in favor high growth stocks are usually fueled by a growing crowd of investors who believe that these exciting returns could last forever. In order to join the crowd chasing the latest fad, the new investors often have to raise funds and abandon their holdings in high-quality, more mature companies that may be situated in lower growth industries. The continuing liquidation in these companies, often selling at ridiculous prices relative to our assessment of their ability to create future free cash flow, can create even more undervaluation until the process eventually ends by value seekers who realize the opportunities in the ignored value stocks and have the patience to wait for the undervaluation to be recognized. At the same time little attention is being paid by the growth investors as to whether or not the rising market prices of the growth companies can be justified by company fundamentals, especially when the converted growth investors net worth is going up every day. In addition, the constant pressure to perform put on investment managers by some financial professionals who use relative performance as a key statistic in selecting investment products results in many money managers staying involved in these high-flying securities regardless of price. Although this time around, the “FANG” stocks (a common reference to four prominent technology companies) were mostly good companies, it is important to pay attention to the price being paid based on a company’s realistic ability to generate future normalized free cash flow. Paying prices for good companies that cannot be justified based on future fundamental potential can result in a great company becoming a bad investment. By way of history, look at what happened to the successful investors in Microsoft and Cisco who made above average returns prior to the year 2000 (the year the NASDAQ topped). For the subsequent 10 to 15 years, investors in Microsoft and Cisco experienced poor returns as their stock prices not only declined. but had to wait until company fundamentals justified the current market prices.
Our recent performance has been positively affected by purchasing, or having the patience to hold, companies that we believe are severely undervalued with widening discounts created by short-term thinking, despite having sound balance sheets, growing free cash flow, and outstanding management teams who focus on sound fundamentals and strategies which are based on creating value for shareholders. Although the value discounts that existed at the beginning of the pandemic have narrowed somewhat, the Funds’ current cash levels should enable us to take advantage of what we believe are undervalued opportunities but are waiting for the right prices to employ the cash, which is how we seek to control downside risk relative to upside reward. The material number of companies that we believe are still undervalued has been exacerbated by the by the long-term migration to passive index investing from active management. Currently, the S&P 500® Index is heavily influenced by the dominant “FANG”-type stocks that must be purchased as new monies come into the passive index funds. We believe the distortions created by the long-term migration to index investing is ready to reverse and a more realistic balance will soon be established between index investors and active managers. Our reversal prediction could result in some rotation from what we believe are overvalued “FANG”-like growth stocks to companies whose current prices, in our opinion, are undervalued and not reflective of their ability to produce normalized future free cash flow, their conservative balance sheets and strong management teams dedicated to building shareholder value.
For the six-month reporting period ended December 31, 2020, Adviser Class shares of the Olstein All Cap Value Fund appreciated 32.36%, load waived Class C shares appreciated 31.70% and load waived Class A shares appreciated 32.18%. During the same six-month period, the Russell 3000® Value Index appreciated 23.56% and the Russell 3000® Index appreciated 25.24%. For the calendar year ended December 31, 2020, Adviser Class shares of the All Cap Fund appreciated 11.13%; load waived Class C shares appreciated 10.06% and load-waived Class A shares appreciated 10.84%. During the same twelve-month period, the Russell 3000® Value Index appreciated 2.87% and the Russell 3000® Index appreciated 20.89%.1
ALL CAP PORTFOLIO REVIEW
As of December 31, 2020, the Olstein All Cap Value Fund portfolio consisted of 77 holdings with an average weighted market capitalization of $149.92 billion. During the six-month reporting period, the All Cap Fund initiated positions in four companies and eliminated its holdings in fifteen companies.
Positions initiated during the last six months include: CBRE Group, Inc. (NYSE:CBRE), Keurig Dr Pepper Inc (NASDAQ:KDP), Quest Diagnostics Incorporated (NYSE:DGX), and SS&C Technologies, Inc.(NASDAQ:SSNC). Positions eliminated during the reporting period include: Aptiv plc (NYSE:APTV), Caterpillar Inc. (NYSE:CAT), Chevron Corporation (NYSE:CVX), Danaher Corporation (NYSE:DHR), Dine Brands Global Inc. (NYSE:DIN), The Greenbrier Companies (NYSE:GBX), Hologic, Inc. (NASDAQ:HOLX), Ingersoll Rand, Inc. (NYSE:IR), Littelfuse, Inc. (LFUS), Middleby Corp. (MIDD), Regal Beloit Corporation (RBC), SeaWorld Entertainment Inc. (SEAS), Snap-on Incorporated (SNA), Thermo Fisher Scientific (TMO), and Zebra Technologies Corporation (ZBRA).
During the reporting period, the Olstein All Cap Value Fund sold its holdings in Aptiv plc, Caterpillar Inc., Danaher Corporation, Dine Brands Global Inc., The Greenbrier Companies, Hologic, Inc., Ingersoll Rand, Inc., Littelfuse, Inc., Middleby Corp., Regal Beloit Corporation, SeaWorld Entertainment Inc., Snap-on Incorporated, Thermo Fisher Scientific, and Zebra Technologies Corporation as the stock price of each of these companies reached our valuation. We should note that many of the stocks in the portfolio rose significantly during the reporting period, which, given our strict sell discipline, triggered the liquidation of fourteen of the All Cap Fund’s holdings that reached or exceeded our value. In fact, six of the above companies – Aptiv, The Greenbrier Companies, Ingersoll Rand, Middleby, SeaWorld Entertainment, and Zebra Technologies increased approximately fifty percent or more in value during the last half of the year. The All Cap Fund eliminated its position in Chevron Corporation as we lost confidence that the company’s free cash flow projections would support our valuation.
All Cap Leaders and Laggards
The Olstein All Cap Value Fund’s leading performers for the six-month reporting period ended December 31, 2020, included: Tapestry, Inc. (TPR), WESCO International, Inc. (WCC), Generac Holdings Inc. (GNRC), FedEx Corporation (FDX) and Middleby Corp. At the close of the calendar year the All Cap Fund continued to maintain positions in Tapestry, Inc., WESCO International, Inc., Generac Holdings Inc., and FedEx Corporation. The All Cap Fund liquidated its position in Middleby Corp. as the price of the company’s stock reached our valuation.
Laggards during the six-month reporting period include: Chevron Corporation, Intel Corporation (INTC), Baxter International Inc. (BAX), Quest Diagnostics and Walgreens Boots Alliance, Inc. (WBA). At the close of the reporting period the All Cap Value Fund maintained positions in Intel Corporation, Baxter International Inc., Quest Diagnostics and Walgreens Boots Alliance, Inc. As previously discussed, the All Cap Fund eliminated its position in Chevron Corporation during the reporting period.
For the six-month reporting period ended December 31, 2020, Adviser Class shares of the Olstein Strategic Opportunities Fund appreciated 46.13%; load-waived Class A shares appreciated 46.02% and load-waived Class C shares appreciated 45.34%. The Strategic Fund’s primary benchmark, the Russell 2500® Value Index, appreciated 33.06% and the Strategic Fund’s secondary benchmark, Russell 2500® Index appreciated 34.90%, during the same period. For the full calendar year ended December 31, 2020, Adviser Class shares of the Strategic Fund appreciated 16.11%, load-waived Class A shares appreciated 15.82% and load waived Class C shares appreciated 14.98%. During the same twelve-month period, the Russell 2500® Value Index appreciated 4.88% and the Russell 2500® Index appreciated 19.99%.2
Strategic Portfolio Review
As of December 31, 2020, the Olstein Strategic Opportunities Fund portfolio consisted of 36 holdings with an average weighted market capitalization of $6.26 billion. During the reporting period, the Strategic Fund initiated positions in four companies and eliminated eight holdings. The Strategic Fund initiated positions in manufacturing company, Brady Corporation (BRC), software company, Intelligent Systems Corporation (INS), clothing company, Levi Strauss & Co. (LEVI), and flooring products company, Mohawk Industries, Inc. (MHK).
The Strategic Fund sold its holdings in AGCO Corporation (AGCO), The Greenbrier Companies, Ingersoll Rand, Littelfuse, Inc., Middleby Corp., Regal Beloit Corporation, SeaWorld Entertainment Inc., and Zebra Technologies Corporation as each company’s stock price reached our valuation. Given the Strategic Fund’s strong investment returns over the second half of 2020, many of the stocks in the portfolio appreciated significantly. In fact, six of the eight companies liquidated from the Strategic Fund’s portfolio – AGCO, The Greenbrier Companies, Ingersoll Rand, Middleby, SeaWorld Entertainment, and Zebra Technologies – each appreciated approximately fifty percent or more during the reporting period.
Strategic Leaders and Laggards
Leading performers for the six-month reporting period include: Tapestry, Inc., Lifetime Brands, Inc., WESCO International, Inc., SeaWorld Entertainment Inc., and Generac Holdings Inc. At the close of the calendar year the Strategic Fund continued to maintain positions in Tapestry, Lifetime Brands, WESCO International, and Generac Holdings. The Strategic Fund liquidated its position in SeaWorld Entertainment as the price of the company’s stock reached our valuation.
Laggards during the six-month reporting period include: NOW Inc., Prestige Consumer Healthcare, Inc., Big Lots, Inc., Central Garden & Pet Company and Regal Beloit Company. We should note that due the Strategic Fund’s strong investment performance, only two of the Strategic Fund’s “laggards” depreciated in value during the reporting period – NOW Inc., Prestige Consumer Healthcare. In fact, Big Lots, Inc., Central Garden & Pet Company and Regal Beloit Company all increased in value, with Regal Beloit appreciating approximately 11% during the reporting period. At the close of the year the Strategic Opportunities Fund maintained positions in NOW Inc., Prestige Consumer Healthcare, Inc., Big Lots, Inc., and Central Garden & Pet Company. As previously discussed, the Strategic Fund liquidated its holding in Regal Beloit Corporation.
REFLECTING ON THE PAST TWENTY-FIVE YEARS
Olstein Capital Management passed a significant milestone during the reporting period, as the Olstein All Cap Value Fund celebrated its twenty-fifth anniversary on September 21, 2020. We are extremely proud of the investment organization we have built, the disciplined application of our investment process and the investment performance we have provided to our shareholders since inception. We believe some of the experiences we faced, and lessons we learned over this 25-year period, are worth reflecting on at this milestone.
Over the All Cap Value Fund’s twenty-five year life, significant events have disrupted and adversely affected equity markets, including, but certainly not limited to: the Asian Financial Crisis of 1997; the Russian Financial Crisis of 1998; the bursting of the Internet bubble in March 2000; the terrorist attacks of September 11, 2001; the corporate accounting scandals of the early 2000s, most notably Enron in 2001 and Tyco International and WorldCom, both in 2002; the global financial crisis of 2007-08 culminating in the collapse of Lehman Brothers in September 2008; the ensuing Great Recession, the infamous Bernie Madoff Ponzi Scheme of 2008; the ongoing European Sovereign debt crisis between 2008 and 2012; the May 2010 “Flash Crash;” the fiscal cliff/debt ceiling crisis in 2011; the Brexit vote of 2016 and, most recently, the COVID-19 pandemic.
Despite all of these major market disruptions, since its inception on September 21, 1995 through December 31, 2020, load-waived Class C shares of the Olstein All Cap Value Fund have had a cumulative return of 990.65% and an average annual return of 9.91%, outperforming the Russell 3000® Value Index, with an average annual return of 8.96%, the Russell 3000® Index, with an average annual return of 9.78% and the S&P 500® Index, with an average annual return of 9.71%, each over the same time period. What is most eye opening to us is that the Olstein All Cap Value Fund (after fees) has not only outperformed its primary benchmark, the Russell 3000® Value Index (no fees deducted), over its lifetime, it has also outperformed the broad-market benchmark Russell 3000® Index (no fees deducted) and the S&P 500® Index (no feeds deducted) over the 25+ year period. We are extremely proud of this achievement since, for about thirteen of those twenty-five years, (since 2007 – more than half of the All Cap Fund’s life), “Value” investing has been out of favor, as indicated by the value versus growth indexes of various investments services. For a value fund to outperform even the broader market Russell 3000® and S&P 500® Indices, which have been dominated by fast-growth companies for significant stretches over the past twenty-five years, is a meaningful data point. Although fast-growing stocks labeled as “growth” companies have outperformed so called “value” stocks over the past 13 years according to Bloomberg, we do not believe that this information is relevant to our brand of value investing. We don’t buy into the notion of differentiating value and growth companies, and can and have found value in so-called growth stocks at various times over the All Cap Fund’s 25+ year history, such as Google, Microsoft, Apple etc., even though they may have been selling at relatively high price-earnings ratios. Our inclusive brand of value investing is driven by whether or not market prices are in accord with our assessment of a company’s discounted ability to generate future free cash flow. The prices of some fast-growing companies at times are not correctly discounting the meteoric growth rates to be experienced over long periods of time by high growth companies. Of course, reaching these earning growth levels for long periods of time should be accounted for by requiring larger discounts to our calculation of intrinsic value and controlling the percentage of the portfolio we are willing to commit to higher-growth free cash flow generating companies based on our assessment of risk. Fast growing companies can be vulnerable to large declines if predicted growth rates are missed, and we do not ignore this risk when purchasing a company with a relatively high price-earnings ratio. According to data supplied by Bloomberg, it is meaningful to note that value stock performance significantly exceeded so-called growth stock performance for the 81-year period between 1926 and 2007, and the relative underperformance of value stocks over the last 13 years appears to be an anomaly. We believe the return to an investor valuing a company based on its fundamental ability to generate future free cash flow, rather than simply chasing optimistic growth assumptions, is not just a passing fad.
Staying Focused on Free Cash Flow
Over the past twenty-five years, we have attempted to anticipate and address the impact of many of the previously mentioned disruptive events on markets, as well as the complications they created in the eyes of the public and the steps needed to be taken to implement our unique value investing approach. We believe our investment success is due to a straight-forward philosophy and investment approach: we are long-term investors who seek to buy companies that trade at significant discounts to our estimate of intrinsic value, which often occurs during short term debacles where the masses often overreact believing the problems will last forever. However, despite periods of relative underperformance, we often find the most compelling opportunities during these disruptive periods in an attempt to increase the probabilities that our long-term investment approach succeeds. Our persistent focus on free cash flow not only guides our search for value, but it also informs and directs our investment analysis and company valuation processes. By focusing on a company’s ability to generate free cash flow, we understand its competitive advantages, the economic reality and profit drivers of its businesses, and in our opinion, can more accurately assess the capabilities of its management thus giving us the confidence to enact our long-term philosophy during turbulent times. As previously mentioned, we do not believe the term “growth” is a different investment category, but rather a component of determining value. We evaluate growth stocks in the same manner as any other company and derive their values in the same manner as any other stock; does the current market price correctly value our assessment of the company’s ability to produce free cash flow over the next 3 to 5 years? By focusing on how well management allocates the company’s free cash flow into thoughtful growth initiatives in rapidly growing markets, where the company is likely to dominate or returns the cash to shareholders through increased dividends, share repurchases or debt paydowns, increases the probability of being more accurate when predicting future growth prospects. Google and Apple have returned nice profits for the All Cap Fund over the years, but their positions have been recently reduced as our assessment of their value discounts have narrowed.
During periods of excessive market volatility, such as those caused by the disruptive market events over the past twenty-five years, our critical focus on free cash flow allows us to identify and separate those factors that are likely to affect a company’s future prosperity from the excessive noise and short-term fear that can characterize turbulent market environments. We attempt to filter a great deal of noise, mainly the onslaught of extreme market predictions and top-down economic news forecasts and data, by focusing on the resiliency of a company’s business model in both favorable and unfavorable economic environments.
By ignoring the “noise”, we can conduct a forensic analysis of company financial statements, public filings, shareholder communications and footnotes to determine the quality of a company’s earnings and make any adjustments to reported earnings that we believe may mask or obscure the company’s true cash flow potential. Over the past 10 to 15 years, GAAP (Generally Accepted Accounting Standards) reporting has been deemphasized by analysists and management adjusted earnings have become the “go to” number. Is that an example of the fox guarding the hen house? We believe our team’s expertise in accounting and financial reporting practices provides us with an advantage in analyzing the reality of reported management adjusted earnings and free cash flow that are a main component of valuing a company. To reliably estimate a company’s normalized future free cash flow, we must also fully understand its business model as well as the success of its strategy, the sustainability of its performance and the impact of management decisions on future cash flow. Our analysis not only seeks to determine how stable a company’s cash flow is but also if we can estimate its future cash flows with a high degree of predictability. Through our analysis we seek to answer several important questions: Does management pay attention to using a portion of free cash flow to enhance the company’s financial strength by improving the balance sheet and/or lower debt? Does the company’s business model produce consistent results with a predictable cost structure? Does the company have a unique niche relative to its competitors that leads to dependable revenues? Does the company have proven products with a well-defined market? Answers to these and other questions help us to determine what kind of multiple to use in our valuation.
As we have said many times before, free cash flow is the lifeblood of a business. Companies that generate excess cash flow also have the potential to enhance shareholder value by increasing dividend payments, repurchasing company shares, reducing outstanding debt, and engaging in strategic acquisitions. Free cash flow generating companies also attract other companies or private equity firms to consider them as acquisition candidates. For us, superior investment opportunities are found in companies that generate sustainable excess cash flow that, in our opinion, is not being properly valued by current market prices. Although it is not our objective to specifically identify companies that are potential take-over candidates, over the last 25 years, we have had over 40 companies in our portfolio acquired at premiums that were led by managements who used excess cash in ways that increased shareholder value, and that we were able to buy at significant discounts to our determination of their intrinsic values.
We recognize that macro-economic factors and other newsworthy events can exert extreme short-term influence over equity prices from time to time, but we are more concerned with how individual companies operate under all types of economic conditions and cycles. We believe it is an important job of company management to adequately anticipate and plan for the impact of economic shifts on their business and its ability to generate sustainable free cash flow. Through our focused analysis, we judge a company’s resiliency in the face of macro-economic shocks and shifts, and incorporate that judgment into our normalized cash flow projections and price to cash flow multiples.
Over the past twenty-five years we have identified many companies that have successfully navigated turbulent economic times to adapt, invest, grow, and restructure for the future. As economic news and events overwhelm equity markets from time to time, we believe it is essential to remain focused on company fundamentals as we wait for equity markets to regain a more balanced perspective. We remind you that, as experience proves, patience can provide an investor with generous opportunities. We intend to stay the course in the current environment as we are invested in companies that, in our opinion, have the financial strength to ride out current market jitters while offering favorable long-term business prospects.
We value your trust and remind you that our money is invested alongside yours as we work hard to accomplish each Fund’s objective of long-term capital appreciation.
Robert A. Olstein, Chairman and Chief Investment Officer
Eric R. Heyman, Co-Portfolio Manager
- The performance data quoted represents past performance and does not guarantee future results. The Olstein All Cap Value Fund’s Class C average annual return for the one-year, five-year, and ten-year periods ended 12/31/20, assuming reinvestment of dividends and capital gain distributions and deduction of the Olstein All Cap Value Fund’s maximum CDSC of 1% during the one-year period, was 9.06%, 9.69%, and 9.54%, respectively. Per the Fund’s prospectus dated 10/28/20, the expense ratio for the Olstein All Cap Value Fund Class C was 2.15%. Performance and expense ratios for other share classes will vary due to differences in sales charge structure and class expenses. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than performance quoted. To obtain performance data current to the most recent month end, please go to our website at www.olsteinfunds.com.
- The performance data quoted represents past performance and does not guarantee future results. The Olstein Strategic Opportunities Fund’s Class C average annual return for the one-year, five-year, and ten-year periods ended 12/31/20, assuming reinvestment of dividends and capital gain distributions and deduction of the Olstein Strategic Opportunities Fund’s maximum CDSC of 1% during the one-year period, was 13.98%, 9.49%, and 8.89%, respectively. Per the Fund’s prospectus dated 10/28/20, the expense ratio for the Olstein Strategic Opportunities Fund Class C was 2.35%. Performance and expense ratios for other share classes will vary due to differences in sales charge structure and class expenses. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than performance quoted. To obtain performance data current to the most recent month end, please go to our website at www.olsteinfunds.com.
The above represents the opinion of the Manager and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. The references to securities are not buy or sell recommendations but are intended to be descriptive examples of the Funds’ investment philosophy and are subject to change. Do not make investments based on the securities referenced. A full schedule of Fund holdings as of 12/31/20 is contained in this report and is subject to change. This information should be preceded or accompanied by a current prospectus, which contains more complete information, including investment objectives, risks, charges, and expenses of the Olstein Funds and should be read carefully before investing. A current prospectus may be obtained by calling (800) 799-2113 or visiting the Olstein Funds’ website at www.olsteinfunds.com.