Bill Miller is the portfolio manager for the Legg Mason Value Trust (LMVTX) fund, which, under his management, recorded one of the longest "winning streaks" in mutual fund history. Between 1991 and 2005, the fund's total return beat the S&P 500 Index for 15 consecutive years.
Miller's fund grew from $750 million in 1990 to more than $20 billion in 2006.
Bill Miller is a value investor who will look at even technology stocks as long as he sees value.
Some of his quotes
Miller’s Definition of Value
“We try to buy companies that trade at large discounts to intrinsic value. What’s different is we will look for that value anywhere we can. We don’t rule out technology as an area to look for value.”
“Our definition of value comes directly from the finance textbooks, which define value for any investment as the present value of the future free cash flows of that investment. You will not find value defined in terms of low P/E [price-toearnings] or low price–to–cash flow in the finance literature. What you find is that practicing investors use those metrics as a proxy for potential bargain-priced stocks. Sometimes they are and sometimes they aren’t.”
“Over the long term [LM Value Trust] has provided shareholders with very attractive returns. However, along the way to this long-term outperformance, the fund has seen numerous quarters of under performance. Performance history suggests that periods of market weakness can be excellent opportunities for investment.”
“Sensitive investors will be prepared for periods, perhaps extended, where returns are well below those levels, or even negative.”
At the close of 1999, the Wall Street Journal claimed that Miller was taking cues from the S&P 500 index itself. The index, overseen by McGraw-Hill Co.’s Standard & Poor’s unit, said the Wall Street Journal “occasionally replaces lackluster businesses with better ones but mostly lets its winners ride.” That is an inexact description of what Miller was thinking, especially since the purpose of any index is to reflect the reality of a particular market, not to outpace it.
“Too many people,” Miller says, “underperform because they have a money management style that makes no sense. Namely, they try to forecast variables that are unforecastable. Nobody can forecast interest rates or GDP [gross domestic product] numbers. People who base their portfolio on forecasts are basing it on something that is inherently subject to large error.”
“Estimates of business value,” Miller notes, “are subject to substantial uncertainty arising from, but not limited to, the availability of accurate information, economic growth, changes in competitive conditions, technological change, changes in government policy or geopolitical dynamics, and so forth. We attempt to minimize the potentially unfavorable consequences of errors in the estimation of business value by building in a margin of safety between our estimates and the price we are willing to pay for a security.”
Despite the drawbacks and limitations, Miller believes that traditional value investing still has merit. “You just can’t use overly simplified valuation techniques to substitute for analysis and thinking,” he warns. And remember, he continues, “we use [valuation] metrics as landmarks and not roadblocks. You don’t want to have a static approach in a dynamic world.”
Besides being backward-looking, Miller says, “P/E ratios by themselves are irrelevant. They capture one factor in a stock and often have little to do with underlying values. Let me explain my approach this way. Somebody said to me six months ago (October, 1999), how could I own Dell Computer and not Gateway because Gateway is a much better value? I said, what do you mean? Well, he said, Gateway trades at 12 times earnings and Dell trades at 35 times earnings, so Gateway is obviously a better value. So I replied that I had two businesses for him to invest in. In one he could earn a 200 percent return on his investment and in the other he could earn 40 percent. Which would he choose? Why, business number one of course, he said, it’s five times as profitable. I said you just described the difference between Dell and Gateway. Dell earns 200 percent on its capital and Gateway 40 percent, yet Dell trades at only three times the P/E of Gateway.”
Miller says other value investors rely too much on “simplistic” tools and mathematical shortcuts that he considers merely “a way to get at a deeper reality,” not an end in themselves. For example, many value investors sell too soon, and thus miss the best gains. What others do, he says, is look at historical trading patterns, then try to pick stocks based on historical relationships. “Then they trade out of them when they hit some other metric that relates to the historical trading pattern.” This type of investor does not grasp the notion that (1) fair value is time sensitive and (2) a strong, expanding business will continue to grow in value, even if the stock is no longer cheap on a price-to-earnings basis.
“People believe that somehow or other there are characteristics of companies that make them growth or value. I believe that growth value distinctions really describe the styles of money managers, not the characteristics of companies. Value managers put valuation as the critical driver in their style. Growth managers focus on growth and underweigh valuation.”
Miller will continue to own a company as long as he is confident of the business value and management’s ability to convert from undervalue to full valuation. “As long as we trust management and believe it’s dealing with us in a fair way, we will hold the stock. Circus Circus [now called Mandalay Resort Group] is a good example. We owned it for three years, and it did nothing but go down. As it turns out, we were too optimistic about the environment in Las Vegas and how that would develop. Even though the stock performed poorly, we kept buying it because the stock price declined more than the business values.” Three years after Miller bought it in 1996, he was vindicated. Mandalay shares doubled in price.
“Most cyclicals operate in undifferentiated commodity businesses with little or no control overproduct pricing, have fluctuating and unpredictable earnings and cash flow streams, no significant competitive advantages, poor returns on capital, and have little or no free cash flow after taxes and capital expenditures. Their reported earnings do bounce around a lot and usually go up as the economy improves. But to earn above average returns in these kinds of stocks requires one to buy and sell at precisely the right time, such timing having little to do with careful analysis of business values and everything to do with guessing inflection points in the economy and market sentiment.”
But, “as the economy expands, these stocks lag, even as earnings begin to materialize. Finally, they fall sharply when the market expects recession and the consequent collapse in their earnings. Over a full economic cycle the performance is usually uninspiring, and over the longer term, often abysmal. General Motors sells today [Spring 1993] for a lower price than it did in the 1960s, and airlines have earned no more money in aggregate since Kitty Hawk.”
“We believe and continue to believe that technology can be analyzed on a business basis, that intrinsic value can be estimated, and that using a value approach in the tech sector is a competitive advantage in an area dominated by investors who focus exclusively, or mainly on growth, and often ignored by those who focus on value."
“We buy businesses that sell at large discounts to our assessment of their underlying value,” he explains. “So the question is, where are the best values in the market? Are they among companies that are growing, companies that are shrinking or are cyclical? We own a lot of technology stocks because we think the best relative values are in that sector.”
In his 1996 annual report, Miller reminded Legg Mason Value Trust shareholders that he would be making what seemed like contrarian choices. The process worked this way: “We are patient, longterm investors who try to invest in solid businesses at bargain prices. This will often lead us to being out of fashion with the market, investing where the press or public have near-term worries.”
“Ignore the headlines and be optimistic—because the American economy is the strongest and most innovative in the world, and to take advantage of its wonderful opportunities, investors really need to think long-term and be patient.”
Bill Miller’s Investment Principles
- Evolve the investment strategy as the environment changes, always keeping a value orientation
- Adopt the strengths, but not the weaknesses, of the competition: the S&P 500 - Like the S&P 500, Miller invests for the long-term remaining fully invested with low turnover. He lets the winners run, while selectively paring the losers.
- Observe, but don’t forecast, the economy and the stock market
- Seek companies with superior business models and high returns on capital over time
- Take advantage of, rather than fall victim to, psychologically driven thinking errors
- Buy businesses at a large discount to the central tendency of their intrinsic value
- Win with the lowest average cost - Confident in his exhaustive analysis, Miller continues buying as a matter of principle and profit as a stock price drops.
- Cultivate a focused portfolio of 15 to 50 businesses
- Maximize the expected return on the portfolio, not the frequency of correct pick
- Sell when 1) the company reaches fair value (but valuation changes over time); 2) you find a better bargain; 3) the fundamental logic for the investment changes
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