Eric Heyman, portfolio manager of the Olstein Strategic Opportunities Fund, screens for companies whose financial resources and management heft can help them overcome strategic challenges and short-term problems reflected in their stock price.

H/T Dataroma

Olstein Strategic Opportunities Fund: Value In Turnaround Situations

Small-to mid-sized companies that have ‘hit the wall’ or stumbled are generally neglected by investors, especially as negative news starts filtering in. Eric R. Heyman, portfolio manager of the Olstein Strategic Opportunities Fund, screens for companies whose financial resources and management heft can help them overcome strategic challenges and short-term problems reflected in their stock price.

What is the history of the company and the fund?

Olstein Capital Management was established in 1995 with an investment style focused on selecting out-of-favor companies with the help of fundamental investing principles.

We recognized that the market systematically overlooks small- and mid-cap companies that face strategic challenges or critical choices and that is where the opportunity lies in creating wealth for our clients. So, we launched the Olstein Strategic Opportunities Fund on November 1, 2006, with the sole focus on companies that have fallen out of favor with investors in that market cap range due to, what we believe, are temporary, fixable problems. Since its inception, the fund has grown to $200 million in assets under management.

How would you describe your investment philosophy?

We look for turnaround situations, or for companies with strong products or services that have either stumbled or that are facing strategic challenges and lack of investor confidence.

A key element of our philosophy is that we treat each company as a business and closely examine its cash flow, balance sheet, and quality of earnings before determining its value. We consider ourselves investors in a business rather than in a stock; therefore, we evaluate the company as if we are buying the entire business. However, these companies should also be trading at material discounts to our estimate of their intrinsic value, because we believe the price you pay for them truly matters.

We believe that free cash flow is the driving force behind any business. If a company does not generate sustainable free cash flow, it does not have opportunities to create value, to buy back stock, or to make acquisitions. So, we look at free cash flow adjusted for capital expenditures and working capital, and we ask what type of free cash flow this business can generate.

Assessing the quality of earnings, accounting practices, footnote disclosures, company’s recognition of revenue policies, how it manages working capital and its pension liability accounting, are some of the core factors to making good investment decisions, especially for companies that are going through a difficult period.

What is your investment strategy?

Investment ideas can come from anywhere and we like to stay curious at all times. In our view, this type of intellectual business curiosity is critical for idea generation. Our team always pays attention to everything, even to details such as what airline people are flying on, where they go out to eat, or what clothes they wear.

In addition, we look for portfolio candidates through our quantitative screening for companies that are buying back stock, have excess depreciation over capital expenditures, return on equity, and stocks trading at a low valuations to normalized free cash flow. Through the financial statements, we want to understand how a company is run and
how we can effectively evaluate management performance.

We also read shareholder letters issued as far as five years back, aiming to see how management has positioned the company and delivered on previous strategic goals, how the business has worked for its shareholders, and how that has impacted the quality of earnings.

Not only do the balance sheet, financial statements and accompanying footnotes indicate the financial strengths and weaknesses; they also show the level of disclosures and help us in understanding how shareholder friendly management is. The higher the level of material disclosures, the greater the level of conviction we have in the company’s
financial statements.

Our investment process is collaborative and involves all our team members. Our daily morning meetings are designed to discuss various stocks and strategies in the portfolio as well as any other ideas that emerge from our research.

Olstein Strategic Opportunities Fund: Value In Turnaround Situations

See full PDF below.