Mutual Funds
A Legend Sizes Up the Market
Legg Mason's Bill Miller has faith in MannKind and sings the praises of a stock everyone loves to hate.
By Manuel Schiffres, Executive Editor
From Kiplinger's Personal Finance magazine, July 2007
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Like fellow Baltimorean Cal Ripken, Bill Miller will forever be defined by the streak. Miller's streak -- beating the return of Standard & Poor's 500-stock index for 15 straight years -- ended with a thud in 2006. His Legg Mason Value Trust trailed the index by ten percentage points. His newer, more-flexible fund, Legg Mason Opportunity Trust, a member of the Kiplinger 25, also lagged, but by only two percentage points.
So is Miller, at age 57, past his prime? Did the pressure of continuing his remarkable run drain him of the zeal to deliver the kind of returns that made him the most famous mutual fund manager on the planet?
Hardly. The streak was overblown to start with. It was partly an accident of the January-through-December calendar year -- Legg Mason trailed the market during a number of other 12-month periods. Still, Miller remains one of the sharpest, most innovative thinkers in the investing game, as we were reminded during a recent interview at Legg Mason's headquarters, next to Baltimore's striking Inner Harbor.
Miller is particularly impressive when he argues about the foibles of most value investors and defends his own approach. In the late 1990s, he was criticized for being a value investor in name only because he owned shares of AOL, Dell and Amazon.com. Today, his big stake in Google once again leads some to question his credentials as a bargain hunter. But Miller turns the tables on his critics.
KIPLINGER'S: How does it feel now that you no longer have to defend your streak?
MILLER: Unfortunately, I still have to bear the burden of competing against the S&P 500. I just have to bear it now without the advantage of the streak.
You've said that you like to take advantage of errors that others make. What are today's big errors? At the broadest level, the big error is in how mega-cap stocks in the U.S. are being valued. I'm talking about companies like General Electric, Microsoft, AIG.
You're not the only one saying this. What will it take to get the mega caps to move? Time. My guess is that they will move this year because they've been cheap for several years, and they haven't done anything in all that time. I expect the economy to slow this year, and historically, that kind of environment has been good for mega caps. In a slowing economy, they're perceived to be safer. And they are safer. The top 50 names in the S&P 500 have lower price-earnings ratios, higher dividend yields, higher returns on equity and capital, better balance sheets, and more-balanced earnings than the bottom 450 names.
Do you make portfolio decisions based on this big-picture analysis? No. We don't have a forecast-and-trend approach -- meaning we don't make a forecast of what we think is likely to happen, or what trends are likely to occur, and then adjust our portfolio to conform to the forecasts. We estimate the intrinsic value of our companies and invest where we can get the greatest discount to intrinsic value. Then we try to understand the environment we're operating in. But we start with valuation -- that's always number one. We're saying that large-cap stocks are cheap historically. Then the questions are: Why are they cheap? What does the environment look like? What's happened in the past? What's caused things to change? We invest where we think we can get the best risk-adjusted rate of return. So we're adding to GE and AIG in Value Trust, establishing a position in GM, and cutting back on stocks with smaller market caps. Opportunity is different because its mandate is so broad.
You'll consider stocks that most value investors won't touch. How do you justify owning a Google? This is what I call the value conundrum. Look at what have been the biggest wealth-creating companies: Microsoft, Wal-Mart, GE, Johnson & Johnson. You could have bought Microsoft in 1991 at 35 times earnings and made 40 times your money over the next ten years. If you had bought Wal-Mart when it went public, you would have paid 20 times earnings and you would have made 10,000%. If a stock goes up 30 or 40 times in ten years, it has to have been grossly underpriced to begin with. So Microsoft was not expensive at 35 times earnings. It was one of the best bargains out there.
In retrospect. Yes, in retrospect. So was Cisco Systems. So were a lot of companies. What are value investors supposed to do? They're supposed to be able to find the bargains. The conundrum is, why do the greatest value-creating companies almost never find their way into value investors' portfolios? And the answer is that value investors won't look at those companies when they're actual bargains because it's hard to tell the difference between them and companies that are valued similarly that aren't going to do that well. So value investors have systematically ignored companies that could have made them huge amounts of money over time because the companies looked expensive on the surface, even though they weren't.