America’s Greatest Unknown Market Analyst

by | Jun 15, 2004

“I happen to love Cleveland,” says Elliott Schlang as we sip our drinks in the dark and stylish bar of the Jefferson Hotel, which, to my parochial Northeast Corridor mind, is about as far from Cleveland as you can get. I happen to love Elliott Schlang, and the fact that he lives in Cleveland, far […]

“I happen to love Cleveland,” says Elliott Schlang as we sip our drinks in the dark and stylish bar of the Jefferson Hotel, which, to my parochial Northeast Corridor mind, is about as far from Cleveland as you can get.

I happen to love Elliott Schlang, and the fact that he lives in Cleveland, far from the madding crowd, has helped make him America’s greatest unknown market analyst. He’s far from Wall Street, keeping his own counsel. You won’t find him touting companies on CNBC or being quoted in Money magazine on the hot stock of the moment.

Instead, for more than 20 years, he has run a low-key research service called LJR Great Lakes Review (the LJR stands for Lynch, Jones & Ryan, the firm that owns the company), whose 60 institutional clients include some of America’s largest mutual funds. But being Elliott Schlang, he won’t divulge the names. He is a discreet Midwesterner, with a voice and a demeanor that remind me of my favorite comedian, the late, great Jack Benny, who grew up in Waukegan, Ill.

Schlang’s job is to provide money managers with ideas — in other words, stocks to buy. Most are companies no one else bothers with because they’re too boring. Take, for example, Littelfuse Inc. (LFUS), a company based in Des Plaines, Ill., that makes, well . . . little fuses, circuit-protection products that are used in automobiles, trucks and machines.

If you haven’t paid much attention to Littelfuse, you aren’t alone. But you have been missing a good bet. While the average stock on the Standard & Poor’s 500-stock index has lost value over the past five years, Littelfuse has doubled.

Another Schlangian success story is Dentsply International Inc. (XRAY), which makes products for dentists, such as false teeth and little tips that go on the water syringes they shoot into your mouth to dislodge the gunk when they are cleaning your teeth. Dentsply also makes lots of money, year after year. Earnings have grown at an average annual rate of 16 percent since 1999, and the stock has roughly tripled, rising steadily even during the long bear market.

Schlang keeps only 30 stocks on his recommended list, and most are solid Midwest burghers that have been in residence for many years. Among them: Lancaster Colony Corp. (LANC), which makes glassware, candles and salad dressings; La-Z-Boy Inc. (LZB), the furniture manufacturer; and one of my all-time favorites, Cintas Corp. (CTAS), which rents work uniforms.

Schlang has a very clear stock-picking strategy, laid out in a three-page manifesto on March 13, 1981, and unchanged since. Few analysts — and I have talked to loads of them over the years — can tell you with clarity how they select investments. Schlang can. His strategy has the traits of his own personality written all over it: moderation, patience, circumspection, integrity. These are the virtues of the American heartland, and, when it comes to stock picking, they work.

He looks for mid-size companies “with an entrepreneurial, aggressive, creative management still relatively immune to the potholes of corporate bureaucracy.” Often they are firms that have been run for many years by a charismatic leader who is also a major stockholder.

A good example is Tootsie Roll Industries Inc. (TR), maker of not only those little chocolate logs but also Charms lollipops, Junior Mints, Sugar Daddies and other delights. Tootsie Roll’s chief executive and chief operating officer are husband and wife Melvin and Ellen Gordon, ages 84 and 72, respectively.

The Gordons own 50 percent of the stock and control 70 percent of the vote. This is not the kind of corporate-governance setup that would thrill a reformer, but Tootsie Roll has been paying dividends for 61 consecutive years and has no long-term debt, loads of cash and a remarkable return on equity. The candy business has been tough lately, but that only makes the stock more attractive, in Schlang’s view.

By the way, like Schlang, the Gordons are discreet. “Management,” writes Schlang in a recent report, “offers no assistance in assessing the Company’s prospects or current operations.”

Once over the mid-cap, entrepreneurial threshold, stocks that qualify for Schlang’s list must have:

1. A bona fide specialty niche. The company requires a moat, or protection against competitors, which would otherwise whittle away profits. How can you tell if the niche is really protected? By the results on the income statement. Companies in exposed positions can increase their profits consistently. Schlang looks for impressive growth in earnings “regardless of external business conditions,” with above-average returns on both sales and equity.

2. A self-funding balance sheet, with little debt. Schlang stays away from companies that need to borrow in order to meet their own capital needs to buy machines and buildings. He searches for businesses that can expand by using the profits they generate themselves.

3. Substantial insider ownership. Options are fine, but Schlang likes companies whose managers, directors and employees own lots of stock. “Their money is on the table with yours,” says Schlang. “They’re playing the same game.” Insiders at Alberto Culver Co. (ACV), a longtime Schlang holding, own 21 percent of the company’s shares; at Cintas, 27 percent. Stephen E. Myers, the chief executive at Myers Industries Inc. (MYE), and his mother, Mary S. Myers, widow of the company’s founder, together own 28 percent of the firm’s stock. Myers, based in Akron, makes plastic containers for plants and flowers, as well as storage tanks and carts — a wonderfully boring, Schlangian business.

4. Few institutional shareholders. Schlang likes companies whose shares are owned by “less than 10 percent of the number of institutions that own the most widely held institutional name, currently Microsoft.” The idea is that, as these hidden gems are discovered, institutions will rush to them and bid up their prices. Tootsie Roll’s shares, writes Schlang, “are tracked on First Call [an analyst-monitoring service] by only one firm, despite the $2 billion market cap.”

5. Domestic orientation. It’s tough enough, says Schlang, to find good companies without having to “assess external political changes and currency valuations.” Thus, he stays away from companies with big manufacturing or marketing operations abroad. An example of domestic concentration is M/I Homes Inc. (MHO), a home builder that Schlang and his partner Gregory W. Halter added to the list recently. Based in Columbus, Ohio, it sells houses in the Midwest, the Washington area and Florida.

6. “Constructive” labor relations. Schlang is not fond of companies that have aggressive unions, and he gives preference to firms that encourage workers to own shares. A good example is Education Management Corp. (EDMC), where an ESOP (Employee Stock Ownership Plan) owns 10 percent of the shares. By the way, the stock of Education Management, which runs for-profit colleges, has quadrupled in the past four years.

7. A “reasonable” price-to-earnings ratio. Schlang isn’t a fanatic on value, however. In assessing a P/E ratio, he takes into account the interest-rate environment (lower rates justify higher P/Es) and the earnings growth rate. And, he emphasizes, “preference is given to a great company over a great stock” — a philosophy with which I enthusiastically agree.

Many companies on Schlang’s list do have attractive valuations. M/I Homes, for instance, carries a current P/E of 7.5. Another stock he recently added, United Stationers Inc. (USTR), the largest domestic wholesale distributor of business products, has a current P/E of 15 and a forward P/E, based on projected earnings for the next 12 months, of 12, which is below the company’s expected rate of earnings growth. A third recent addition, Thor Industries Inc. (THO), maker of recreational vehicles, including the gorgeous Gulfstream, has a forward P/E of 13 and a projected earnings growth rate for the next five years of 14 percent.

8. A senior management that’s high in integrity. “Companies,” Schlang writes, “are the sum total of the human beings that manage them.” In our conversation at the Jefferson — my first face-to-face meeting with a man I have written about for six years — Schlang said flatly that the most important factor in judging a company is knowing the person who runs it. “There is no substitute for personal acquaintance.”

Think of Schlang and Halter as the two-person membership committee of an exclusive Cleveland club. “Frequent and direct management contact is required.” For that reason, since he started Great Lakes Review he has made it a rule that the companies he analyzes have to be nearby, so he can easily visit: Ohio, Michigan, Illinois, Indiana and western Pennsylvania. That’s all.

But how can a small investor assess the integrity of managers? I ask. “People know companies in their own towns,” he responds. “Follow your natural instincts. Follow media coverage. Listen to what people say about local executives. They can’t get away with murder in their own communities.”

Schlang is not always right. Too Inc. (TOO), a retail clothing chain that caters to what he calls “the highly erratic young woman,” lost nearly half its value last year. Schlang took it off the list, not because of the price decline but because of his sell discipline, which stresses “a deterioration in long-term fundamentals, not . . . short-term blips or investor fancy.”

And, while he leans toward boring manufacturers — one of his favorites is Hillenbrand Industries (HB), a Batesville, Ind., company that makes caskets — he doesn’t eschew high-tech businesses. His list includes Steris Corp. (STE), which makes sophisticated infection-prevention equipment — I saw the machines in action on a recent trip to a super-clean Merck vaccine plant in Pennsylvania — and Zebra Technologies Corp. (ZBRA), a company based in Vernon Hills, Ill., that puts bar-code labels, and more advanced ID tags, on products.

“If I had to pick one company where earnings can exceed expectations next year,” he says, “this is it. Zebra.” The Defense Department and Wal-Mart Stores (WMT) are requiring labels that can be tracked through wireless signals on practically everything they will be purchasing. Zebra stands to benefit.

The stock doesn’t appear cheap. It’s trading at a P/E of 40 after quadrupling over the past five years, but sales rose 24 percent in the last quarter, and Schlang, in his low-key way, is a big fan of Zebra. And, as you have probably guessed by now, I am a big fan of his.

Ambassador Glassman has had a long career in media. He was host of three weekly public-affairs programs, editor-in-chief and co-owner of Roll Call, the congressional newspaper, and publisher of the Atlantic Monthly and the New Republic. For 11 years, he was both an investment and op-ed columnist for the Washington Post.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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