Contrarian value: Bill Miller’s investment approach

Wednesday, Aug 01 2012 by
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Contrarian value Bill Millers investment approach

In brief 

Bill Miller is co-founder and current chairman of US investment group Legg Mason Capital Management. He rose to prominence during the 2000s for consistently beating the US stock market with a blend of contrarian value and growth strategies. 

Background 

Miller and his partner Ernie Kiehne set up Legg Mason Capital Management and served as portfolio managers of the Legg Mason Capital Management Value Trust from its start in 1982 until Miller took the reigns as manager in December 1990. 

Between 1991 and 2005 Miller cemented his legendary reputation by guiding the Value Trust to a record 15 consecutive years of beating the S&P 500. In 2012, and after 30 years in charge, he retired from the Value Trust but continues to run Legg Mason’s Opportunity Trust. 

While some industry commentators concluded that Miller’s remarkable record was simply down to chance, others have given him more credit. In his book, More Than You Know: Finding Financial Wisdom in Unconventional Places, Legg Mason’s chief investment strategist Michael Mauboussin, insisted that “long streaks typically indicate skill”. Miller himself told the Wall Street Journal that the 15-year streak had been “maybe 95% luck”. 

Investment strategy 

Miller has been described as a contrarian, value-oriented investor whose strategy focused on buying cheap stocks and holding them for the long term, subscribing to the same value school as Ben Graham and Warren Buffett. Some analysts have contended that his investments also owed a great deal to “growth” strategies. Indeed, Value Trust’s performance was supported by a basket of tech stocks, including the likes of Amazon and Dell. 

In a report to Value Trust investors in 2002, Miller acknowledged that a year earlier he had changed his approach in response to the funds underperformance in three of the previous four years. He observed that “the traditional value style, based on low price-to-earnings (p/e), low price-to-book, or low price-to-sales, while delivering solid long-term results, was also subject to uncomfortably long droughts.” After reviewing the data, he concluded that “the conventional wisdom about value investing was wrong”. 

He went on to claim that the source of excess returns had little to do with pure accounting factors such as low p/e or low price-to-cash flow, but instead had more to do with changes in the return on capital. “Low p/e stocks usually had low valuations because they had low returns on capital. If the return on capital didn’t improve, neither did the valuation,” he said. 

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Miller’s successful approach combined statistical cheapness with an analytical view about when a company’s return on capital would begin to improve. He said this theoretically enhanced returns by improving the timing of purchases as well as eliminating companies that looked cheap but weren’t, since they could not systematically improve their return on capital. 

Does it work? 

Miller’s 15 year record of beating the S&P elevated him to celebrity status among investment professionals. While commentators have since debated whether luck or skill was ultimately responsible, the Legg Mason Value Trust nevertheless produced a reported 830 percent cumulative return over 14 years. However, in the years that followed, Miller’s fortunes changed and the Value Trust went on to perform poorly. In particular, it was criticised for buying a handful of financial stocks far too early as the market crash was still unfolding. In 2008, Miller reiterated his commitment to value investing strategies but acknowledged “the best time to open an account with us has always been when we’ve had dismal performance, and the worst time has always been after a long run of excess returns”. 

From the source 

Unlike his investing guru peers, among them Peter Lynch and Martin Zweig, Miller has never written a book about his strategies although others have. In 2002, Janet Lowe wrote The Man Who Beats the S&P: Investing with Bill Miller, which received mixed reviews. Meanwhile, in Quantitative Equity Portfolio Management: An Active Approach to Portfolio Construction and Management, Ludwig B Chincarini and Daehwan Kim also discuss Miller’s investment approach. 

Perhaps the most accurate insight into Miller’s thinking and investment tactics are his commentaries in annual reports to Value Trust shareholders, beginning with his 2002 letter, which set the scene for his now-famous 15-year run. 

Investment formula 

Stockopedia’s interpretation of Miller’s strategy is derived from the book Quantitative Equity Portfolio Management. Miller’s criteria are not easy to screen for in detail because much of his approach wasn’t purely quantitative. However, the criteria we use gives a representation of some of the qualities of companies that were akin to his style. 

  • Price /Free Cash Flow < 3
  • Free Cash Flow > FCF 1 Year Ago
  • Trailing Twelve Month (TTM) Price Earnings Growth (PEG) ratio < 1.5
  • Sales 5y CAGR % > 0
  • Rank ( Mkt Cap £m ) > 25%
  • Debt To Assets < Industry Group Median

 



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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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About Ben Hobson

Ben Hobson

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Strategies Editor at Stockopedia.  I make sure that Stockopedia is delivering the features that its members want to see.


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