Editor's Note: The following is an excerpt available exclusively at TheStreet.com from an interview originally published by Value Investor Insight. Longtime financial sleuth Robert Olstein is a skeptic at heart. "I always focus on what can go wrong first," he says, explaining that long-term outperformance is "highly correlated with avoiding serious errors." This "defense first" approach has served him well: Through June, the $1.9 billion ( OFALX) Olstein Financial Alert fund has returned an average of 15.9% annually -- vs. 9.4% for the S&P 500 -- since the fund was started in 1995. Olstein finds today's market lacking valuation extremes, and that is fine with him. "It's a stock-picker's market," he says. Do your good ideas have any recurring themes? Some of our best investment ideas have been in situations where one division is performing extremely well while another division is being revamped, and the public is unduly focused on the underperforming division. That's currently the case with CKE Restaurants ( CKR), where the Carl's Jr. division is performing extremely well, while Hardee's is only now improving after years of underperformance. Another similar example was Tupperware ( TUP). They started selling in retail stores in the U.S., which turned out to be a total disaster, masking the fact that their international "Tupperware party" business was fantastic. They pulled out of retail in the U.S. and are in the process of building the traditional domestic business back up, while Europe is still going gangbusters. Our stock went from $16 to $23. Another good flag for us has been when depreciation starts exceeding capital expenditures. Hasbro ( HAS) is a great example. Two things had happened with Hasbro. One, it had a lot of licensed products that were losing money because they paid so much to license things like Disney ( DIS) or Star Wars characters, while games like Monopoly were making a lot of profit. On top of that, the company was working off a lot of depreciation and amortization from prior licensing deals -- far above their capital expenditures.
So they were reporting earnings of $1 a share, but they really had more like $1.40 of free cash flow. Once the market recognizes things like that, prices tend to adjust upward. We're actually seeing a lot of companies with excess depreciation now, as a result of the capital-spending boom from 1995 to 2000. We've had good success in the past few years in companies like Disney, McDonald's ( MCD) and Home Depot ( HD) when management, interestingly enough, came out and said they were going to grow less. We own a position in Cisco ( CSCO) now, which we think is worth $22 a share. It recently got blasted down to what we paid for it, around $17, because the company said they were not going to be able to grow 10% a year.
CSCO now trades at $17.74. The people expecting growth of 15% beat the stock down to where it's selling at 16-17 times earnings. With companies like this, when expectations become realistic and the market says Cisco is worth $22-$23 a share even at 5% growth, you can make some nice money. Unfortunately these aren't usually doubles but 30%-40% gainers. How important to you is a dialogue with management? We care a lot more about what management is doing, which is very well documented, than what they are saying. I can learn everything I need to know about management by looking at the numbers. I can see how conservative they are. I can compare three years of shareholder letters and see if they are discussing problems openly and addressing them. If a company isn't discussing any problems, I don't believe what they're saying. I can see if disclosure is complete and easy to understand. If I have to call to get something important explained, there's something wrong. In 38 years in this business, I have yet to hear management warn of an existing problem that, if not resolved, would result in a dramatic drop in the share price. That's exactly what I care about.
We sometimes buy companies with bad management, if that fact is more than accounted for in the price. At a cheap-enough price on a decent business, I'm willing to ride out any problems until somebody, if not current management, figures out how to turn things around. Isn't a management change what attracted you to Playtex? Yes. What originally attracted us to Playtex ( PYX) was their hiring of Neil DeFeo as CEO in late 2004. DeFeo was successful in turning around and selling Remington Products, and he has an excellent record in the consumer products industry. That was the "heat": we knew who he was and his track record. When he came in, he talked about being able to take out $35 million-$40 million in costs, about better managing their brand franchises, about how the lack of sales growth was inconsistent with the opportunity. When he started following up with action -- signing licensing agreements to add to the brands, selling the Woolite product line -- we started looking more closely. Tell us a bit more about the company. Playtex is a consumer-products company with what we consider to be excellent secondary brands like Wet Ones, Playtex and Banana Boat. Many of the brands are under the radar screen, which we like to see from a competitive standpoint. They operate mostly in the infant, feminine care and sun care areas. The thesis is pretty straightforward. The plan is to introduce new products, sell nonstrategic assets, reduce infrastructure and pay down debt -- which we believe will result in higher margins and additional free cash flow. The key for the stock will be growth. They're going to have to spend to grow revenues, but they should have the money to spend from cutting costs elsewhere and further asset sales. If they can grow sales even 2%-3%, there's big upside in the share price. If costs are down, the leverage from increased sales would likely be significant. Exactly. With only 2%-3% top-line growth, we think after-tax margins can go from 4% to 8%, and the earnings power is closer to $1.25 a share. Consumer products companies growing in the 2%-3% range sell for 17-18 times earnings. So if they can make it work, it's not a stretch to see Playtex going to $20. The way we look at it, with the proper financial metrics we have time to find out whether this guy can do what he says he can do. We think they're only in the second or third inning of a nine-inning ballgame.