Dear Fellow Shareholders:
THE MARKET
Aided by a strong year-end rally, equity markets delivered solid returns in 2023, with the broad Russell 3000 Index posting a return of 25.96% and the S&P 500 Index appreciating 26.29% for the calendar year. Despite these strong returns, equity markets faced significant challenges throughout the first nine months of the year. The Fed raised interest rates continuously throughout the period in an attempt to cool down a rising inflationary environment that was capable of hindering future economic growth (e.g., a recession). The Fed paused the interest rate hikes in September of 2023 (fearing an overreaction or even a recession), which ignited a strong market rally.
During the last quarter of the year, equity markets posted robust gains with the broad Russell 3000 Index appreciating 12.07% and the S&P 500 Index appreciating 11.69%. We also note that both of our Funds achieved double-digit returns during the fourth quarter with Adviser Class shares of the Olstein All Cap Value Fund increasing 11.37%, and Adviser Class shares of the Olstein Strategic Opportunities Fund increasing 14.44%.
We are not market timers and focus on long-term returns. In order to be in sync with our long-term strategy, it is necessary to ride out periods of underperformance, which unfortunately leads some investors to liquidate Fund positions at the wrong time. Many investors fantasize about finding strategies that work all the time, but we believe at best this is wishful thinking. We use periods of investor negativity to purchase what we believe are high-quality companies experiencing short-term problems at prices that now represent material discounts from our calculations of intrinsic value (which are based on their capability to produce normalized future free cash flow). In essence, we use periods of negativity to purchase what we believe are high-quality companies being affected by issues having little to do with a company's long-term values, such as missing or making quarterly estimates by immaterial amounts, analyst buy and sell recommendations, market calls by investment gurus predicting short-term overall market moves (especially down moves), earnings predictions by management, etc., etc. The chart on page 13 illustrates on a quarterly basis the value of a hypothetical $10,000-dollar investment made in the Olstein All Cap Value Fund Class C share using historical prices from the inception date (September 21, 1995), with dividends and capital gains reinvested but no deduction of taxes on reinvested distributions. The chart clearly illustrates that past periods of underperformance by the Fund were usually followed by longer periods of outperformance.
The Magnificent Seven stocks accounted for a significant amount of the S&P 500 Index appreciation in 2023, as well as for the past 5 – 10 years. The growth over the last 5 – 10 years not only increased the Magnificent Seven's market capitalization at a more rapid rate than most stocks included in the S&P 500 Index, in addition, the small basket of consistent outperformers increased their weightings (% of the index when calculating the overall S&P 500 Index returns). The large price appreciation of the Magnificent Seven in 2023 was responsible for a material amount of the gain in the S&P 500 Index and was the reason that most stocks in the index trailed the overall Index returns.
STRATEGY
As the economic outlook continues to improve and inflation continues to drop (which we believe is likely to continue), it is important to consider the likely sources of future long-term, above-average equity returns. Many investors believe that whatever has been working (outperforming) or not working (underperforming) in the recent past will go on forever, which of course is not true. The current environment is an opportune time to look beyond the limited number of high-growth stocks that have outperformed the S&P 500 Index over the last 5-10 years to find new leaders. We believe that some of the high-growth Magnificent Seven stocks have grown to prices that already have largely incorporated their expected future free cash flow per share, which should result in these stocks giving up their outperformance crown to new leaders going forward. We believe the last few years have created a new group of highly undervalued securities and we are spending our cash (currently about 10% of assets) to buy these undervalued stocks at prices we believe increase our chances to outperform the S&P 500 Index in the future.
At the beginning of their 5–10-year period of market leadership, the limited number of high-growth market-leading stocks were called FAANG stocks (consisting of Facebook, Apple, Amazon, Netflix, and Google) and have recently been renamed the “Magnificent Seven” (Amazon, Alphabet, (Google's parent), Nvidia, Tesla, Apple, Meta Platforms and Microsoft). We note that our Funds have periodically owned, subject to price, Magnificent Seven stocks (except for Amazon and Tesla) and continue to own several of the stocks as of December 31, 2023. We still believe the Magnificent Seven stocks held by our Funds are undervalued, but we have reduced our positions over time, reacting to the lower discounts that we believe they are currently selling for.
All of these high-growth companies grew rapidly over the last 5-10 years and have become material parts of the S&P 500 Index and carry large weightings when measuring their relative appreciation against all other stocks in the Index. Leaders often go through price corrections as valuations grow faster than free cash flow at times (creating periods of overvaluations in these stocks). We believe that many excited investors seeking the consistently above-average appreciation returns of the Magnificent Seven are rushing into these stocks based on price momentum, rather than on the basis of company fundamentals and values. This continuing price appreciation is raising questions whether or not these current prices are already fully discounting their expected future growth in free cash flow. We believe that paying the right price for future appreciation is the single most important factor determining our Funds' future returns and achieving their overall long-term capital gains objectives. We value all companies on a market price to our projection of a company's future free cash flow per share ratio (market price per share/free cash flow per share) and seek to identify and purchase future market leaders at discount prices to our calculations of intrinsic value, which we believe increases the likelihood that our Funds reach their long-term capital gains objectives.
However, it is significant to note that in 2023 these market-leading high-growth stocks were erasing more than 80% of their 50% or more price corrections that occurred during 2021 – 2022. We believe the quick turnaround in 2023 resulted in market prices that in some cases exceeded the companies' ability to generate discounted future free cash flow per share. We believe many investors are now holding or purchasing Magnificent Seven-type stocks at lower discounts and higher prices to expected future free cash flow ratios per share. In our opinion, several of the Magnificent Seven companies were no longer selling sufficiently (if at all) below our calculation of future intrinsic value to warrant the risk of holding or buying large positions in these companies at current market prices. In addition, at the same time, many high-quality industrials, financials, medical suppliers, material suppliers, and transportation companies were underperforming, presumably as investors were overreacting to speculation about rising interest rates. In addition, we believe investors seeking to raise money to participate in the consistent Magnificent Seven appreciation and outperformance are overreacting by selling these high-quality underperforming and undervalued stocks, creating greater discounts to our calculation of intrinsic value. These discounts have finally started to attract investors looking for value.
We believe eventually the smaller future returns we are predicting for the Magnificent Seven should result in money flowing out of these highly owned stocks and back into the large number of high-quality, highly undervalued stocks that permeate the S&P 500 Index, such as the financials, material suppliers, medical suppliers, industrials, transportation stocks, etc. It is our opinion that our Funds' future returns are going to be highly influenced by the prices we pay for these undervalued companies that we expect to be future market leaders. As previously stated, we believe the Magnificent Seven market leaders are going to show slower future appreciation as their price discounts have already been reduced by their outstanding leading price appreciation in 2023. Currently, we are finding many high-quality stocks that are selling at large discounts to their ability to generate future normalized free cash flow. As previously stated, we believe these stocks' recent underperformance was caused by temporary factors which are about to turn around. We have always focused our portfolio selection for our Funds on undervalued individual companies. Our current portfolios are filled with companies that we believe have unique business models, competitive advantages, strong balance sheets, stable cash flow, and above-average operating returns. We believe our focus on analyzing company fundamentals, particularly our emphasis on looking behind the numbers of financial statements, footnotes, SEC filings, disclosure practices, and accounting assumptions, helps us to determine whether company financial statements are in accord with economic reality (which is an almost forgotten process today). Our accounting skills should provide our Funds with a competitive advantage to determine values in the current environment by adjusting what we believe are often unrealistic or overly conservative assumptions reflected in the current era of MANAGEMENT-ADJUSTED EARNINGS. We believe the current obsession of investors to own fully priced “Magnificent Seven” type stocks is about to slow down. We are taking advantage of the current situation by adding high-quality cyclical stocks that have underperformed the market as a result of factors that have little to do with their long-term ability to generate increasing future free cash flow. The most important determinant of a Fund's future returns is not overpaying for companies we believe are selling at a large discount to their future ability to generate free cash flow (their value). Overpaying for growth often results in below-average long-term returns.
We believe it is now an opportune time to consider those areas of the equity market likely to benefit from potential interest rate cuts and improved economic growth. We see compelling value opportunities across a number of undervalued sectors, such as Financials, Consumer Discretionary, Financials, Industrials, and Materials, Transportation, Medical Manufacturers and Distributors, etc.
In addition, as we have practiced during our 28 years, we continue to invest in what we believe are high-quality companies with unique business models, competitive advantages, strong balance sheets, stable cash flow, above-average operating returns, and a commitment by management to make decisions based on increasing shareholder value. We believe our focus on company fundamentals, particularly our emphasis on future free cash flow, realistic accounting, conservative balance sheets in combination with having management teams who demonstrate a strong commitment to maintaining a strong financial position, should allow us to identify those companies that not only have focused their priorities during economic slowdowns, but have also identified options that can create a substantial strategic advantage as the economy improves and thus more likely to outperform in the future. Patience is the most important attribute of a value investor.
STICKING TO OUR PHILOSOPHY
For the portfolios of the Olstein All Cap Value Fund and Olstein Strategic Opportunities Fund, we remain focused on individual companies, their operations, and their prospects for maintaining or growing sustainable future free cash flow. As long-term value investors, we recognize that companies generating sustainable and or growing free cash flow are well-positioned to compete profitably during an improving economic environment. The Olstein All Cap Value Fund and Olstein Strategic Opportunities Fund portfolios consist of companies that we believe have sustainable competitive advantages, discernible balance sheet strength, and management teams that emphasize deploying excess free cash flow to create value for shareholders. The most important factor that determines future Fund returns is paying the right price for each company added to the portfolio. In essence, the question we ask is whether or not current prices of stocks we are considering adding to the portfolio have an appropriate discount to our calculation of their intrinsic value, or is the future cash flow growth already being discounted by current market prices. In essence, buying companies for the portfolio at the right discount increases the possibility of the Fund outperforming. We believe all of our portfolio companies have the ability to generate sustainable free cash flow and demonstrate a commitment to maintaining a strong financial position. We will continue to seek and invest in companies that we believe have the ability to deliver long-term value that, in many cases, is not properly recognized by the market and are selling at material discounts to intrinsic value. To repeat, it is our strong belief that the price you pay for good companies is the major determinant of long-term returns and reduction of risks (price, price, price).
THE OLSTEIN ALL CAP VALUE FUND
For the six-month reporting period ended December 31, 2023, Adviser Class shares of the Olstein All Cap Value Fund appreciated 3.08%, Class C shares appreciated 2.58%, and Class A shares appreciated 2.92%. During the same six-month period, the Russell 3000® Value Index appreciated 6.36% and the Russell 3000® Index appreciated 8.43%.
PORTFOLIO REVIEW
At December 31, 2023, the Olstein All Cap Value Fund portfolio consisted of 78 holdings with an average weighted market capitalization of $140.04 billion. During the six-month reporting period, the Fund initiated one position and eliminated its holdings in five companies. During the reporting period, the All Cap Value Fund initiated a position in Vontier Corporation, and sold its holdings in Intel Corporation, Prosperity Bancshares, and WestRock Company, as the price of each stock reached our valuation level. The Fund sold its holding in Tapestry, Inc., a long-term holding that we believe performed well over its time in the Fund's portfolio, but we liquidated the stock after the company announced a major acquisition that significantly altered our investment thesis for the company. The Fund also eliminated its position in Generac Holdings, a five-year holding that we believe performed well, to invest the proceeds in opportunities that we believe had a more favorable risk-reward profile.
Our Leaders
The Olstein All Cap Value Fund's leading performers for the six-month reporting period ended December 31, 2023, include: Intel Corporation (INTC, Financial), WestRock Company (WRK, Financial), Fifth Third Bancorp (FITB, Financial), US Bancorp (USB, Financial), and Citizens Financial Group (CFG, Financial). At the close of the reporting period, the Fund continued to maintain positions in Fifth Third Bancorp, US Bancorp, and Citizens Financial Group, and had sold its holdings in Intel and WestRock, as previously discussed.
Our Laggards
Laggards during the six-month reporting period include: Tapestry, Inc. (TPR, Financial), Generac Holdings (GNRC, Financial), Southwest Airlines (LUV, Financial), Hormel Foods (HRL, Financial), and LKQ Corporation (LKQ, Financial). At the close of the year, the Fund continued to maintain positions in Southwest Airlines, Hormel Foods, and LKQ Corporation, and had eliminated its holdings in Tapestry and Generac, as previously discussed.
THE OLSTEIN STRATEGIC OPPORTUNITIES FUND
For the six-month reporting period ended December 31, 2023, Adviser Class shares of the Strategic Opportunities Fund appreciated 4.61%, Class A shares appreciated 4.45%, and Class C shares appreciated 4.01%. The Fund's primary benchmark, the Russell 2500® Value Index, appreciated 9.59%, and the Fund's secondary benchmark, Russell 2500® Index, appreciated 7.93%, during the same time period.
As of December 31, 2023, the Olstein Strategic Opportunities Fund portfolio consisted of 36 holdings with an average weighted market capitalization of $5.05 billion. During the reporting period, the Fund initiated two new positions and eliminated four holdings. The Fund initiated positions in First Advantage Corporation and Vontier Corporation. The Fund eliminated its holdings in Generac Holdings, Kontoor Brands, Tapestry Inc., and the WestRock Company. The Fund sold its holdings in Kontoor Brands and the WestRock Company as the price of each company's stock reached our estimate of its valuation. The Fund eliminated its position in Generac Holdings, a four-year holding in the Fund's portfolio that we believe performed very well, to invest the proceeds in opportunities that we believe had a more favorable risk-reward profile. The Fund eliminated its position in Tapestry, Inc., a stock that we believe performed extremely well over its three-year holding period, but sold the stock after it announced a major acquisition that significantly altered our investment thesis for the company.
Our Leaders
Leading performers for the six-month reporting period include: Kontoor Brands (KTB, Financial), WestRock Company, Graham Corp (GHM, Financial), Cushman & Wakefield (CWK, Financial), and Citizens Financial Group. At the close of the reporting period, the Fund continued to maintain positions in Graham Corp, Cushman & Wakefield, and Citizens Financial Group. The Fund eliminated its holdings in Kontoor Brands and the WestRock Company, as previously discussed.
Our Laggards
Laggards during the six-month reporting period include: The Shyft Group (SHYF, Financial), Tapestry Inc., Generac Holdings, Vishay Intertechnology (VSH, Financial), and Zimmer Biomet Holdings (ZBH, Financial). At the close of the reporting period the Fund continued to maintain positions in The Shyft Group, Vishay Intertechnology, and Zimmer Biomet Holdings. As previously discussed, the Fund eliminated its positions in Generac Holdings and Tapestry during the reporting period.
Confidence in Fundamentals – Favoring the Rational Over the Emotional
Although a strong fourth-quarter rally allowed equity markets to deliver strong returns for the calendar year, volatility and speculation about the market's overall future direction characterized the market for the first nine months of the year. The onslaught of negative news, predictions, and speculation about the economy, inflation, recession, and interest rates in particular, caused many investors to engage in emotional decision-making – to forego logic and reason and unfairly punish companies with strong fundamentals due to their heightened fears. Such investor behaviors, exacerbated by the constant drumbeat of negative news, create wide disparities between the price of a company's stock and what we believe to be the true value of its underlying business. Our investment approach seeks to capitalize on these short-term deviations and often has set the stage for us to deliver superior long-term investment returns.
We believe that instead of relying on emotions that unfortunately influence many investment decisions, it is extremely important to remain focused on company fundamentals and have the capability to look in and behind the numbers in financial statements to determine whether or not the financial statements are in accordance with economic reality. As long-term investors, we attempt to capitalize on market fluctuations by buying stocks at bargain prices created by negative market psychology, emotional decision-making, investor misperceptions, and overreactions to company-specific news. Raytheon is one portfolio holding in the All Cap Value Fund and we thought it would be helpful if we summarized how investor emotions can create significant value opportunities.
RTX – Crisis Creates Opportunity
On July 25, 2023, RTX Corporation (RTX, Financial) (formerly Raytheon Technologies Corporation), a multi-national Aerospace & Defense company, reported that its subsidiary, Pratt & Whitney, identified a manufacturing quality issue with certain powdered metals in certain GTF engines produced in prior years, which required an accelerated fleet inspection. During its earnings conference call in July, the company indicated that the issue affected approximately 1,200 engines, 200 of which had to be inspected by mid-September because of their time in service. The remainder would need inspection over the next twelve months. The quality issue did not impact engines currently being produced. Following the July 25th disclosure of the engine issue, the price of the company's stock fell approximately 10%.
On September 11, 2023, the company provided an update on the financial impact of the engine issue, as well as details of its remediation plan. RTX recorded a pre-tax operating profit charge in the third quarter of 2023 of approximately $3 billion, which reflected Pratt & Whitney's estimate of the losses to be incurred by Pratt & Whitney's 51% share of the joint venture that makes the PW 1100 GTF engine. This charge included estimates of potential compensation and other considerations for customer fleet disruption and the one-time impact of estimated incremental costs to long-term maintenance contracts as a result of this matter, including the cost of additional inspections, replacement of parts and other related costs. Following the September 11th announcement of the financial impact and details of its plan to correct this issue, the price of the company's stock fell another 8%. In fact, between the start of the reporting period for this shareholder letter on July 1, 2023, shortly before the initial announcement of the engine issue and the close of the third quarter on September 30, 2023 (shortly after the announcement of the $3 billion charge to address this issue), the price of the company's stock fell approximately 26% and its market capitalization shrank by approximately $37 billion. Of course, this experience isn't representative of every holding in the Funds.
As value investors, we often identify opportunities in companies affected by overreactions to bad news. We believe that the market's short-term reaction to such situations as that experienced by RTX can create profitable opportunities for the patient long-term investor. When we identify companies that have been unduly penalized by short-term thinking, our primary focus is to determine the expected financial impact of the problem on the company's long-term intrinsic value. A 26% drop in the company's stock price that wiped out $37 billion in market capitalization for what is approximately a $3 to $3.5 billion issue piqued our interest.
From experience, we know that temporary issues affect every company from time to time. Some issues are financial, some operational, some strategic – but all eventually weigh on the stock price in the near term. Our analysis in such situations focuses on two keys questions: (1) is the problem likely to cause long-term erosion of the company's intrinsic value, and (2) does the company's remediation plan adequately address the problem and its impact within a reasonable time frame? Staying focused on answering these questions is critical in our analytical and decision-making processes.
From our perspective as a long-term holder of its stock, RTX is a well-run company with a strong track record of providing high-quality products and services. Additionally, we believe RTX is doing the right thing by taking care of its clients with its corrective course of action. As a result of our analysis of the issue and the company's corrective course, it is our judgment that the issue is temporary and fixable and did not merit the market's overreaction. We believe the financial impact of the issue to be approximately $2 per share of intrinsic value – a far cry from the $26 drop in the company's stock price from June 30 to September 30, 2023.
Going forward, while the stock may continue to be impacted by earnings revisions, press coverage, and other near-term concerns, we have a $115 value for RTX after our last earnings review, which incorporates the costs of the company's remediation plan. During the three-month period when extensive reaction to the engine issue caused the price of RTX stock to drop, we accumulated shares at what we believe to be very favorable prices, significantly increasing the size of our holding. As of the close of 2023 and into 2024, the price of RTX stock has bounced back nicely and as of February 1, 2024, has traded above $92 per share. We continue to monitor RTX, and developments related to the engine issue, and we will adjust our determination of intrinsic value based on revised estimates of future excess cash flow as the company reports its financial results.
FINAL THOUGHTS
It is important to note that our confidence in the long-term prospects of RTX Corporation, as with many previous holdings in companies that successfully addressed operating issues and/or turnaround situations, is rooted in our investment process and our emphasis on company fundamentals, including the company's accounting assumptions and disclosure practices. It is important to note that our portfolio management team, which includes Bob Olstein, Eric Heyman, Tim Kang, and John Sullivan, who have been together for nearly two decades, have extensive experience in analyzing financial statements, footnotes, proxy statements, etc., looking for alerts of undervaluation or overvaluation not yet recognized by the public.
As value investors, we believe it is vital to maintain a long-term perspective in an environment maniacally focused on short-term news and events. We believe our long-term horizon, when combined with our emphasis on company fundamentals, should increase the possibility of achieving our Funds' investment objectives of long-term capital appreciation.
We value your trust and remind you that our money is invested alongside yours as we work hard to accomplish the Funds' objectives of long-term capital appreciation. We wish you a happy, healthy, and prosperous 2024.
Sincerely,
Robert A. Olstein
Chairmand and Chief Investment Officer
Eric R. Heyman
Co-Lead Portflio 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 12/31/23, 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 10.39%, 9.53%, and 6.41%, respectively. Per the Fund's prospectus dated 10/28/23, the expense ratio for the Olstein All Cap Value Fund Class C was 2.16%. 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 12/31/23 is contained in this report and is subject to change.
