Bob Olstein, chairman and chief investment officer of Olstein Capital Management, answered our 10 Questions.
This article first appeared in the February/March 2011 issue of Morningstar Advisor magazine. Get your free subscription here.
What type of returns do you expect from stocks over the next few years?
High single digits.
What would you tell investors who might be worried about budget deficits?
I'd tell them that stocks have climbed a wall of worry for 42 years. The bigger the worry, the better the returns. The stock market is a discounting mechanism. Valuations based on free cash flow are as cheap as I've ever seen relative to U.S. Treasury bonds.
Do you buy the argument that large-cap, high-quality companies are the cheapest part of the market?
I don't know if they're the cheapest, but they are the cheapest they've been since 1973-74.
Why do you rarely hold companies based outside the United States?
I have enough trouble understanding U.S. accounting to worry about foreign accounting, currency problems, and government problems.
What's your favorite accounting metric?
The difference between reported earnings and free cash flow, because reported earnings are based on the accrual method of accounting, which requires a lot of assumptions on the behalf of management, and sometimes those assumptions are a little bit unrealistic.
Are accounting practices better or worse today than they were when you started looking at them in the 1970s?
Accounting behavior is contra-cyclical to valuations. Right now, we have the highest quality of earnings that I have seen in my 42 years in the business. But stay tuned. As valuations climb, so does accounting chicanery. High valuations have to be justified.
What's the first stock you ever bought?
Varo. They made night-vision equipment for the military back in the Vietnam War days. I bought the stock at the wrong price. Their use of accounting trickery led me to emphasize quality of earnings. It was a great lesson.