Bill Miller had one of the greatest investment streaks ever. For 15 consecutive years, running the Legg Mason Value Trust, he beat the S&P 500 by about five percentage points.
Miller joined Legg Mason in 1981 as an analyst. He took over sole management of the Legg Mason Value Trust in November 1990. It turned out to be a perfect time to invest.
His streak began the next year. Miller described the feat as “a large degree of luck, and maybe some modicum of skill. And I’d define skill as actually just surviving in markets over long periods of time without blowing yourself up.”
A big reason behind the streak was a shift in Miller’s philosophy. In the early 1990s, Miller realized that some companies might be statistically expensive but are bargains because of their superior long-term growth potential. The market recognizes some of that potential but fails to price all of it in. A few companies have a built-in advantage to outperform — already high expectations — for years.
A strategy tied to bargain companies with high growth potential led Miller to tech companies like Dell, AOL, and Amazon well before the Dotcom era peaked and at a time when most value funds avoided tech like the plague. Then he shifted gears again in late 1999 to more traditional value plays when tech valuations became unsustainable.
The ability to see things from a different perspective and the flexibility to adjust to wherever the best values lie sets Miller apart from other value investors. You can find it throughout his annual letters, commentary, and interviews.
On Investment Process
As we have written many times, we do not believe that carving the world into ‘‘value’’ or ‘‘growth’’ is a sensible or useful way to think about the investment process. Growth is an input into the calculation of value. Companies that grow are usually more valuable than companies that don’t. If a company earns below its cost of capital, though, then the faster it grows, the less it’s worth. Companies that earn returns on capital above their cost of capital create value; those that earn below it destroy value. Those that earn returns equal to the cost of capital grow value at the rate they add capital. — Source
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What we try to do is find companies whose economic models support returns on capital above the cost of capital, so that they create value at a rate greater than the mere addition to capital that occurs through the retention of earnings in the business. Such companies usually are recognized by the market and valued appropriately, but sometimes they are available at discounts to intrinsic value. These discounts can arise for many reasons. The most common are macroeconomic change, problems with the company or its industry, or the immaturity of the business. In each case, the long-term economics of the business are obscured by factors or events that prove to be temporary. These temporary factors produce the mispricings that eventually lead to excess returns. — Source
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Stock prices change far more rapidly than does intrinsic business value. That is because prices reflect recent history, current fundamentals, and reasonably foreseeable prospects, those looking out say six to nine months, all filtered through the prism of psychology and emotion.
A critical part of our process is normalization. When the economy is in recession, that is not a normal condition and it is reasonable to position portfolios for recovery when prices reflect recession, not recovery. When the economy is growing at unsustainable rates, as it was in late 1999, it makes sense to adjust valuations for more normal conditions, if the market has not done so. — Source
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Technology was cyclical as well, but many tech companies were able to maintain returns on capital above the cost of capital despite their cyclicality. We had learned something about analyzing these companies when we bought IBM in 1993 near the bottom. It was our first attempt to implement a strategy of buying businesses that were statistically cheap but whose business model would support high returns on assets or equity with significant free cash flow generation. Such companies could be held longer in the portfolio with better long-term returns for shareholders than if we tried to buy and sell stocks based on some sense of how they were likely to perform over the next year. That was the theory, anyway. — Source
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We try to buy companies whose shares trade at large discounts to our assessment of their economic value. Bargain prices do not occur when the consensus is cheery, the news is good, and investors are optimistic. Our research efforts are usually directed at precisely the area of the market that the news media tells you has the least promising outlook, and we are typically selling those stocks that you are reading have the greatest opportunity for near-term gain. — Source
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Part of what people insufficiently distinguish, or confuse, is the difference between frequency and magnitude — that is, how often you’re right or wrong versus how much money you make when you’re right and how much money you lose when you’re wrong. — Source
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Our approach can be summarized with the phrase “lowest average cost wins.” For most investors if a stock starts behaving in a way that is different from what they think it ought to be doing — say, it falls 15 percent — they will probably sell. In our case, when a stock drops and we believe in the fundamentals, the case for future returns goes up. — Source
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What we’re really trying to do is abstract away from all the day-to-day noise and stuff that appears in the papers or on television, or the clamor about what you ought to be doing now, and really think about how we can acquire interest in businesses that will be much more valuable many years down the road. What that involves is an analysis of the companies, of the management; especially how they allocate capital of their competitive position. And then we value these businesses. — Source
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The most important thing is not so much the performance as the process. A good process will ultimately lead to good results in the long run, so you can’t be distracted by what happens in the short term. — Source
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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. — Source
On Bear Markets
All of the great investing periods begin when things are terrible and end when they are wonderful. The best time to buy stocks in the 1930’s was at the bottom of the Depression in July 1932; in the 1940’s, at the outset of World War II. In the 1970’s, you could not have done better than buy during late 1974, a time of rising rates and inflation, an oil embargo, recession, and a constitutional crisis with Watergate. The worst recession since the Depression hit in 1982. Rates were double digit, and inflation nearly so; Mexico defaulted on its debt, and a 17-year bull market was just beginning. — Source
On Behavior
Our memory provides continuity and context to our daily activities, enabling us to recognize familiar situations, see their similarities and differences, integrate experience into a broader context, draw lessons from the past, and so on. Investment memory, though, seems considerably more short-term, selective, and sub-optimal. Normal memory, though far from perfect, allows us to function reasonably effectively; investment memory often fails just when it is most needed. We don’t remember that similar situations have occurred in the recent past; we don’t put current events in perspective. The result is sub-optimal investment decisions. — Source
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One of the most powerful sources of mispricing is the tendency to over-weight or over-emphasize current conditions. — Source
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How do you react to stress? To losing? To winning? When do you go “on tilt,” to use a gambler’s term? In addition to knowing yourself, you also have to know how most people react most of the time. Most people like to buy after a stock has gone up, or when it appears to be in a rising trend. They sell after a stock has declined, often after unexpected bad news has been reported. In order to earn excess returns, one has to anticipate changes in expectations, not react to them. — Source
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For most investors in general, selling the expensive asset, and buying the cheap asset, seems like a logical strategy – except when you actually try to do it. Because most people are actually not wired to be selling what’s expensive and going up, and buying what’s cheap and going down… Because when they buy what’s going down, it hurts. — Source
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In a market that’s informationally efficient in the short term, thinking three years ahead is likely to be more effective than thinking three to six months ahead. This assumes that the investor is fundamentally oriented, not technically oriented, where short-term price trends drive behavior. — Source
On Mistakes
I think that most individual investors make great mistakes when they try and time the market, and try and think about what’s the best stock to buy now. What individual investors should understand is that, broadly speaking, the U.S. economy is going to be larger and more successful in five years or ten years than it is right now… And that if you’re optimistic and think long-term, and really diversify your portfolio, you’ll do wonderfully well. You’ll do better than almost anybody else in the marketplace who’s too caught up in the short run. — Source
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There is a tendency to look to the past and say, these things have done well and therefore that’s the way you should invest — as opposed to saying where are the greatest investment opportunities going forward. — Source
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The problem is that real risk and perceived risk are two different things. And that’s where people get into trouble, because they perceive risk to be high when prices are low, and they perceive risk to be low when prices are high. That’s the psychological problem that most people have. — Source
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Almost every value trap is the result of people extrapolating past returns on capital and past valuations onto a different situation today. — Source
On Gambling (and Investing)
Despite its lurid aspects, gambling is also one of those activities that repays careful study, since understanding what constitutes intelligent gambling can lead to more intelligent investing. — Source
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One of the first things to notice about professional gamblers is that there are no professional roulette players, slot players, or craps or keno or lottery players. That is because you cannot win at those games; the house has a mathematical edge. The longer you play, the more certain it is you will lose. — Source
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In order for someone to make a living at gambling, the game has to be one where a mathematical advantage accrues to the most skillful player, where intelligence, hard work, and careful analysis can make a difference to the outcome. As with most such endeavors, there are many who compete, but only a few who achieve world class results over long periods of time. — Source
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The major difference between investing and gambling is that gambling is a zero sum game, for every winner there is a loser. Investing is a game where everyone can (theoretically) win, i.e., increase their wealth, either by making their capital available to others for a fee – earning interest – or participating in the growth of the economy through stocks. It is really hard to lose all your money by investing in stocks and bonds, though some have perhaps succeeded, and really easy to lose it all gambling, which no doubt contributes to its bad reputation. — Source
On the Market Being a Discounting Mechanism
The key question in markets is always what is discounted. Excess returns are earned when expectations — what is discounted — are different from what occurs. — Source
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When we initiate a new position, it is not uncommon for a client to call and say, “Don’t you read the papers? This company has serious problems.” One of the things we tell our analysts is, if it’s in the papers, it’s in the price. Meaningful price changes only occur when new, previously unexpected information appears. — Source
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I’m always struck by the comment about the disconnect between the market and the economy. Because basically, the market predicts the economy, the economy doesn’t predict the market. And so, the market is looking forward. — Source
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As I’m fond of telling the analysts, if it’s in the newspapers, it’s in the price. So you really need to understand what isn’t in the price, what isn’t being discounted, what events can happen that will lead the market to think differently about things. — Source
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The more things people worry about the better for an investor, because those worries are already instantiated in the overall market. — Source
Related Reading:
Bill Miller’s Biggest Loss
3 Sources of Investor Advantage