Brent Olson // Co-Portfolio Manager // Aquila Three Peaks Opportunity Growth (ATGAX)

Comments & Outlook

We see the high-yield bond market as a leading indicator for equities.

Based on the strength of the high-yield market, now and in the last several years, we think we’re in a full-tilt bull market for stocks.

The default rate on high-yield is incredibly low now, about 1 percent vs. 4.5 percent historically, so we have a very healthy credit picture.

Companies are also issuing debt at a record rate. About $380 billion in high-yield bonds was issued last year, and we’re already at $150 billion so far in 2013.

The proceeds are mainly being used by companies to improve their debt profile by lowering coupons, pushing out maturities, and to otherwise strengthen their finances. This is creating the underpinnings for strong equity performance.

Investment Strategy

We apply bond metrics to buying stocks. Basically, we use our high-yield bond research, which is based on companies’ deleveraging patterns, to determine if we want to buy a stock. We’re particularly interested in companies that are paying down debt and improving their balance sheets. We’ve found that when companies are noticeably improving their credit outlook, this makes for a very good stock story.

Portfolio Picks

One of our largest holdings is Cooper Companies (NYSE: COO), the world’s third-largest contact lens manufacturer.

Most people have never heard of Cooper, but over the years it has taken its debt down from about $1 billion to $300 million.

Berry Plastics (NYSE: BERY) makes rigid and flexible plastic packaging, and it used the proceeds of its initial public offering last year to deleverage.

The company has said it plans to use future free cash flow to further improve its debt profile, and we think this will benefit the stock price. In fact, we think an improving debt profile will be one of the main drivers for this stock going forward. So this is a good example of our investment approach at work.

Lions Gate Entertainment (NYSE: LGF) tapped the high-yield market to fund its acquisition of Summit Entertainment, whose Twilight and Hunger Games movies have had great results. So LGF has effectively used the high-yield market to boost its business and is now paying that back.

Eric Heyman // Portfolio Manager // Olstein Strategic Opportunities Fund (OFSAX)

Comments & Outlook

Strong corporate balance sheets will lead to increased share buybacks, more dividend increases and more mergers and acquisitions. And a lot of investors with low-yielding investments still sitting on the sidelines will continue to shift into equities. All these things create a powerful tailwind for the overall market.

Investment Strategy

We take a private-equity approach and focus on leading small and midsize companies that face unique challenges and which the markets have discounted, even though they may be correcting their problems.

A lot of investors take reported earnings at face value and plug them into their models. We don’t. Using forensic accounting techniques, we examine five years of financial history to get a true understanding of the numbers, especially free cash flow (FCF). [FCF is net income plus all non-cash charges, such as depreciation/ amortization, minus capital expenditures.]

Unlike reported earnings, FCF is what a company actually has to spend on creating value, on things like share buybacks, dividends or acquisitions. So it is the lifeblood of any company and a strong determinant of its value.

We also look at what management said it would do three to five years back, and how well they’ve executed on those plans.

Portfolio Picks

Thor Industries (NYSE: THO) is a leader in the recreational vehicle (RV) and bus market, with #1 and #2 market shares. It has an excellent management team and solid balance sheet. We think the cloud around the RV industry will start to lift as the economy continues to improve. And Thor is coming into this next cycle stronger than before having used the downturn to streamline operations and make some savvy acquisitions.

We see annual free cash flow north of $3.50 per share. The stock was at $35 recently, well below our three-year price target of $50.

Maidenform Brands (NYSE: MFB), a leader in women’s intimate apparel, has suffered from retailer destocking and competition. They’ve had a great run in the shapeware category, and they’re now focused on marketing and streamlining their offerings and distribution.

There’s also potential for international expansion; foreign sales were only 8 percent of revenue recently. We think fair value is $25 vs. $18 recently.