Quick Take: Legg Mason Equity Value Fund (LMVTX), run by Bill Miller, is well-known as the only mutual fund to beat the S&P 500 in each of the last 11 years. Nancy Dennin, the fund’s assistant manager, credits this success to Miller’s focus on the long term, generally the next three to five years, instead of the 12-month time frame she says most fund managers consider.
Miller believes the market bottomed in July and is poised for gains for the next three to five years. While returns will be spotty, Miller see opportunities in the telecom and health-care industries.
Taking the long view, Miller often moves into depressed areas while they’re still out of favor, as the fund has with such telecom picks as NEXTEL Communications (NXTL) and Qwest Communications Intl (Q). Dennin notes that, while the fund’s long-term record still stands, these early moves into turnaround situations can hurt near-term returns.
This year through August, the fund lost 18.9%, versus a 19.4% drop for the S&P 500 and a 19.8% decline for the average large-cap blend fund. For the ten-year period through August, the fund rose an annualized 15.7%, compared with a 10.4% gain for the index and a 9.2% gain for the peer group.
The Full Interview
S&P: What’s driving the fund’s performance this year?
DENNIN: This August, many of our very depressed names bounced back, including Tyco Intl (TYC), which is up 24%; NEXTEL Communications`A` (NXTL), up 35%; and Qwest Communications Intl (Q), up 135%. These were the same stocks that hurt our performance over the last 12 months.
So far this year, we’ve been early in many positions before they’ve rebounded. Unlike many funds, we have a long time horizon — typically three to five years. Often, it takes 12 months before a holding’s problems get sorted out, such as an earnings hiccup or a management problem. In many cases, we’ve bought stocks that were very controversial because of their difficulties, such as Amazon.com (AMZN) a year ago when it was expected to go bankrupt.
S&P: The fund is well known as the only fund to beat the S&P 500 for the last 11 years. What does Bill Miller feel accounts for this success?
DENNIN: Bill absolutely looks out over the long term. He’s very good at looking at changes in the big picture. Most portfolio managers only focus on the next 12 months, but that time period is basically priced into the stocks. Because of his record, Bill has the unique flexibility to buy something that will work in the next three to five years, but not necessarily for the next 12 months. Most portfolio managers haven’t been through a bear market, so a lot of them are frozen and don’t know what to do.
Equally important, Bill has the courage of his convictions. After we’ve done the fundamental work and Bill believes a stock is trading at a discount to its intrinsic value, he’ll buy more if it goes down. Many fund managers might get scared and sell a stock when it goes down 20%. Bill’s adage is ‘the lowest average cost wins.
S&P: How does Bill Miller define value investing?
DENNIN: Like Warren Buffett, we believe growth is part of value. We define value investing as buying companies that are trading at a discount to their intrinsic value. Many people believe value companies have low price/earnings ratios. But, we feel many companies with low price/earnings aren’t trading at a discount to their intrinsic value.
S&P: How do you determine a company’s intrinsic value?
DENNIN: It really depends on the individual company. We decide on a company’s intrinsic value based primarily on its cash flow generation, although we also consider enterprise value, p/e ratio, price to book, and price to liquidation value.
Ideally, we like to buy companies trading at a 50% discount to our estimate of their intrinsic value. But, it’s not a static valuation approach, so we’ll buy stocks trading at less than a 50% of their intrinsic value if we feel strongly about their fundamentals.
S&P: What’s the fund’s view of the market going forward?
DENNIN: We think the market bottomed last July. While the market has currently priced in lower revenue growth for the next three to five years, we think stocks will do very well over that period.
Broadly speaking, we believe there are no big industries where there will be robust revenues, such as in the 1990s, when technology was strong. The U.S. market is a mature market, and the U.S. economy is a mature economy. It will be more of a stock picker’s market.
S&P: Will certain areas of the market do better than others over the next three to five years?
DENNIN: Bill feels that you don’t buy what worked in the last five years. You try to buy what will work in the future. Bill thinks companies with relatively higher dividend yields and relatively higher dividend growth rates will be rewarded with higher multiples going forward. With concerns about corporate governance, people say dividends don’t lie. Among companies generating free cash flow, the smarter managements will return some of that cash flow to shareholders.
We think telecom is a promising sector, but it will be more individual stocks rather than the whole area. We also think several health-care companies will do quite well because of the aging of the baby boomers. Some utilities also look good.
S&P: Have there been any changes in the fund over the last 12 months?
DENNIN: Several of our financial services holdings have done well, leading to a larger weighting in that sector. Since many are now trading at a premium to our assessment of their intrinsic values, we’ve reduced or sold some names whose fundamentals have deteriorated. One holding, Washington Mutual (WM), is up 16% for the year.
S&P: You also bought Tyco this year.
DENNIN: We’ve always had Tyco on our radar screen because several well-known value managers have been very successful with it. Given where the stock is currently trading, we think Tyco can still earn a good return, although not much above nominal GDP growth. When the stock got down to $25, we began buying it in a small way, believing its business is worth $50. We also bought it at $8 to $9.