What You Can Learn From Shareholder Letters

One of the fundamental tenets of our investment philosophy at Olstein Capital Management is that a forensic analysis of a company’s financial statements, regulatory filings and accompanying footnotes reveals the quality of a company’s earnings, the success of its strategy, the sustainability of its performance and the impact of management decisions on future free cash flow. We believe that a forensic analysis of company balance sheets, income statements, and other regulatory filings is more useful when assessing a company’s ability to produce future free cash flow than management forecasts, earnings forecasts, or company visits.

While most investors usually pore over the pages and pages of financial data that companies provide, they often overlook or skim the Letter to Shareholders at the beginning of each annual report. Investors also often fail to adequately read earnings releases, conference call transcripts, the quarterly SEC filing Form 10-Q, other SEC filings (e.g., Form 8-K, proxy statements, etc.) and company press releases. These communications contain valuable information, some of which we uncover by “reading between the lines” looking for “heat” or other subtle messages. Shareholder letters and earnings-related reports usually discuss the company’s recent performance and its future prospects and may provide a more detailed discussion of the strategy that management believes is the right course for the company to follow. A careful reading enables us to determine whether management emphasizes the importance of financial strength, cash flow, working capital controls and the company’s competitive position within its industry. A good shareholder letter, in our opinion, describes how the company’s strategic planning process anticipates and responds to the ever-changing economic, industry or competitive environment and thus provides insight into the quality of management and their commitment to creating meaningful shareholder value over time.

The Importance of Reviewing Shareholder Letters in Today’s Economic Environment

A thorough review of the shareholder letter has become indispensable for gaining insight into a company’s priorities during the tumultuous economic environment of the past several years and provides a valuable way of judging the effectiveness of management’s decisions and overall performance during these difficult times. Never has the adage, “when the going gets tough, the tough get going,” been truer than during the past three years.

Over the past several years we have focused, first and foremost, on management’s discussion of the company’s financial strength and the potential of short-term decisions to materially affect longer-term value creation. We have sought to answer several related questions, including:

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