Olstein All Cap Value Fund’s second quarter letter to shareholders for the fiscal year ended June 30, 2014.
Dear Fellow Shareholders:
For the fiscal year ended June 30, 2014, Class C shares of the Olstein All Cap Value Fund appreciated 21.74%, compared to total returns of 24.61% and 25.22% for the S&P 500® Index and the Russell 3000® Index, respectively. For the quarter ended June 30, 2014, Class C shares of the Olstein All Cap Value Fund appreciated 3.39% compared to total returns of 5.23% and 4.87% for the S&P 500 Index and the Russell 3000 Index, respectively.
Olstein All Cap Value Fund: Market Outlook
Despite a sharp contraction in the U.S. economy during the first quarter of the year, as well as rising global tensions due to armed conflict in Eastern Ukraine and in the Middle East, U.S. equity markets continued to chug along with the benchmark S&P 500 Index increasing 7.14% for the first six months of the year. With the strong market run now five years old, some forecasters are warning investors of an imminent pull back or decline. The ability to sell at market tops and buy at market bottoms is the dream of every portfolio manager, as the ability to perform this timing feat should produce meteoric investment returns. Rather than engaging in what we believe is an unachievable and long-term failure strategy of seeking to time when to be in or out of the overall market, our strategy is to pay the right price for stocks of financially strong companies selling at a discount to our calculations of intrinsic value, and to sell stocks when they reach our calculation of intrinsic value. Our proprietary intrinsic valuation method is based on looking behind the numbers of a company’s financial statements to determine a company’s normalized ability to generate and grow free cash flow. If we cannot find companies to purchase at our required discount, we sit with cash until opportunities present themselves. Thus, Olstein All Cap Value Fund’s method of timing is company based, by which the Fund keeps cash until buying opportunities present themselves that offer the Fund an appropriate risk reward ratio and sells holdings when individual stocks reach our calculation of intrinsic value. Thus, the magnitude by which a company’s stock price is below our calculation of a company’s intrinsic value (defined as the discount) determines the amount of our cash holdings. In addition, we adjust the size of our positions according to the magnitude of a stock’s discount. Hopefully, paying the right price for a stock and the ability to hold cash when individual stock prices are judged to be too high to buy, in combination with our commitment to selling fully valued securities, should help the Fund mitigate the impact of overall market declines on the Fund’s portfolio over time.
While many investors are nervous about what they believe is an imminent correction in equity markets or remain sidelined waiting for accelerated economic growth, we are continuing to apply our discipline by investing in the equity securities of companies with stable or growing free cash flow, whose real economic value we believe is unrecognized by the market (obscured by market uncertainty or overshadowed by temporary problems). No methodology works all of the time but our objective is to be right over time.
Olstein All Cap Value Fund’s Strategy
We continue to seek and invest in companies that we believe have an ability to deliver long-term value to shareholders that we believe is not currently recognized by the market. In 2014, we remain focused on three primary, company-specific factors: (1) a commitment to maintain a strong financial position as evidenced by a solid balance sheet; (2) an ability to generate sustainable free cash flow even under tough economic circumstances; and (3) management that intelligently deploys cash balances and free cash flow from operations to increase returns to shareholders. By prioritizing these factors, our portfolio consists of companies that should be positioned to compete more advantageously as economic growth accelerates.
Against an improving economic backdrop, we also continue to emphasize the quality of a company’s earnings in 2014. By highlighting the quality of a company’s earnings, we seek to accomplish two objectives. First, we assess the financial risk inherent in each investment opportunity before considering the potential for capital appreciation. While many investors are obsessed with short-term market volatility, our primary concern is to avoid or mitigate permanent impairment of capital. We believe our relentless focus on the quality of earnings provides a valuable tool for achieving that objective. Second, we identify those companies that we believe have focused their priorities during the economic recovery to establish the financial wherewithal and internal operating infrastructure to achieve a substantial strategic advantage for the acceleration of economic growth.
Olstein All Cap Value Fund’s Leaders
The stocks which contributed positively to performance for the twelve month reporting period include: Harman International Industries Inc./DE/ (NYSE:HAR), Legg Mason Inc (NYSE:LM), Delta Air Lines, Inc. (NYSE:DAL), Spirit Airlines Incorporated (NASDAQ:SAVE), and Apple Inc. (NASDAQ:AAPL). At the close of the fiscal year, the Fund continued to maintain a position in each of these holdings.
Olstein All Cap Value Fund’s Laggards
Laggards during the twelve month reporting period include: Fairway Group Holdings Corp., Staples, Inc., Coach, Inc., Bed Bath & Beyond, Inc. and Teradata Corporation. During the fiscal year, the Fund eliminated its holding in Fairway Group Holdings Corp (NASDAQ:FWM), Staples, Inc. (NASDAQ:SPLS) and Coach Inc (NYSE:COH). As of the close of the fiscal year, the Fund continued to hold Bed Bath & Beyond, Inc. and Teradata Corporation. Despite Bed Bath & Beyond Inc. (NASDAQ:BBBY)’s recent weak stock performance caused by investor fear that internet-based retailers (particularly Amazon) would cause a permanent deterioration in sales, we believe Bed Bath & Beyond, Inc. can continue to grow its free cash flow, albeit at a slower growth rate. The current stock price, in our opinion, discounts too pessimistic of a scenario in view of the fact that the company continues to generate more than sufficient free cash flow growth and we believe that growth should continue into the foreseeable future. After the close of the fiscal year, the stock has rebounded on news that the company would undertake an aggressive $1.1 billion accelerated stock repurchase program. Similarly, we believe investor sentiment has turned unduly negative on Teradata Corporation (NYSE:TDC), (a long-time holding in the Fund since 2008), based on fears that newer technologies may effectively replace the company. We believe newer technologies will, in fact, complement Teradata Corporation’s data warehousing and analytic capabilities in a growing market segment.
Olstein All Cap Value Fund’s Portfolio Review
We continue to focus on how individual companies have adapted their expectations, strategic plans and operations to recent bumpy economic conditions, and how they have managed their assets to deliver future earnings to investors. Our current portfolio consists of companies that, we believe, have a sustainable competitive operating advantage, discernible balance sheet strength and a management team that emphasizes decisions based on cost of capital calculations and deploys free cash flow to create shareholder value. At June 30, 2014, the Olstein All Cap Value Fund portfolio consisted of 105 holdings with an average weighted market capitalization of $53.12 billion.
During the fiscal