|
The opinions and conclusions expressed herein are those of Litman/Gregory Fund Advisors, LLC (LGFA) and Bill Miller at the time the material is written and may not be reflective of current conditions.
Bill Miller is a sub-advisor in the Masters' Select Equity and Masters’ Select Value funds. Miller has been in the investment business and with Legg Mason Fund Advisers, Inc. since 1981. He was named co-manager of Legg Mason Value Trust in April of 1982 and was named sole manager in 1990. In March 2006, Mary Chris Gay was named the assistant manager on the Legg Mason Value Trust. Miller is also the sole manager of Legg Mason Opportunity Trust.
When I was nine or ten years old, I was watching my father read the financial pages of the newspaper, which had a different visual aspect from the sports pages. I asked him what that was. He said those were stocks and stocks’ prices. I then asked what that meant. He pointed to one name and said, “If you look here you’ll see it says plus one quarter. If you owned one share of that company, you would have 25 cents more today than you had yesterday.” I said, “What do you have to do to make it go up 25 cents?” He said, “Nothing, it does it by itself.” It was that conversation that got me interested in the market. I thought, “Wow! You can make money without doing any work. That’s the business I want to be in.” I probably had come in from mowing the grass for 25 cents for 2 hours, so this stock thing sounded like a pretty good deal. Much later I realized it was only the market rate of return that took no work. Getting an extra rate of return was a different matter. More generally, successful investing involves trying to figure out how the world works, where it is going and doing both better than other highly skilled and motivated practitioners. So for someone who is both highly competitive and intellectually curious, it is an ideal activity.
As far back as I can remember, I’ve always thought the right way to learn something is to determine who’s the best at it and see what he or she does. It seemed fairly clear to me in the early 1970s that Ben Graham was the intellectual leader of the security analysis field. Then, reading about Warren Buffett and seeing how he had survived and prospered during the difficult period from the late 1960s to the early 1970s was a real eye-opener. It also always made intuitive sense to me to try and buy things at the best possible price in relation to underlying value. Most people, for whatever reason, seem more psychologically attuned to buying companies that are growing, have great prospects, or have something people can get excited about. Valuation tends to be a much less important factor to most people than it is for me.
I try to approach the investment process with an open mind, try to remember the key investment question is always "what is discounted," and the most important feature of the market is
non-stationarity, that is, things change. Most people are rightly suspicious when they hear “it’s different this time” without fully understanding that it’s different every time. The trick is to understand the key similarities and differences and what they mean for one’s investments.
Our general methodology begins with analyzing stock factors and ends with evaluating the future prospects of a business and valuing those prospects. We begin by looking at accounting-based factors such as low P/E, low price-to-book, and low price-to-cash flow ratios. We look at anything that appears cheap statistically and we use computer screens to identify a universe of names to investigate more deeply. We adjust accounting metrics for the underlying economic reality.
We try to understand what a company does and what its competitive advantage is. Most important, we try to understand the long-term economic model of the business. How much capital does it require to operate? What returns are normal in the industry? Where is the company positioned in the industry? Can its management execute in a way to deliver the business model?
We use a multivariate approach in analyzing stocks in all sectors in order to build a margin of safety into the research process. We evaluate companies using a variety of valuation methodologies such as discounted cash flow, peer group analysis, private market value analysis, sum-of-the parts valuation and other approaches which help to identify the important variables that represent value in a business. We assign higher discounts rates for certain industries and sectors such as technology in order to incorporate the higher level of uncertainty sometimes present in those businesses. Because we do not know which valuation methodology is the best indicator of underlying value at a company, we try to evaluate companies from as many different approaches as possible and look at the central tendency or average of the results that are produced.
We are long-term investors. Our turnover rate has been running between 15 and 20 percent a year, implying a holding period longer than 5 years. We look at whether a company is undervalued over a much longer time period than the average investor. “Undervalued” implies that you will earn an excess return over your forecast time horizon. We are very patient and will own a company as long as we are confident of the business value and of management’s ability to execute the strategies they have outlined. As long as we trust management, believe it’s dealing with us in a fair way, and the value is there, we will hold the stock.
The success that I’ve had is more properly thought of as the success that flows from a team effort driven by an intense desire to generate good returns for shareholders by employing a disciplined valuation methodology. When we say we are value investors, both of those words are important to us – value and investing. Many people who call themselves value investors do not value businesses, they evaluate stocks primarily on historical relationships between price and accounting based stock factors. Second, they don’t invest in businesses, they trade stocks, usually based on historical valuation metrics. What captures people’s attention when they look at our portfolio are names such as Amazon, Yahoo or Google – stocks that are mostly being bought by growth investors – or more accurately, being sold by growth investors, since those stocks are down this year. In the mid to late 1990s, it was Dell and AOL that people focused on, and which we bought when they were really cheap. We made 30 or 40 times our money on those two. Most investors rarely hold companies long enough to make 30 or 40 times their money. They’re lucky if they make 50, 100 or 200 percent. You usually get very large returns only if you actually invest in companies as opposed to trading them. We don’t spend a lot of time trying to guess stock price action. We spend our time trying to value businesses. Because what we do is dynamic valuation, our models are updated every quarter, or more often as we get more fundamental data. We’re always trying to figure out the underlying business value and the intrinsic value of a company. We are also patient and are willing to hold onto a company that may be ahead of itself in the near term but which our research indicates is significantly undervalued over the long-term.
The analysts’ job is pretty much the same as in most places. They follow companies, build models, estimate intrinsic values, analyze information, make recommendations and so one. The analysts and portfolio managers are all on the same floor and interact both informally by talking to each other, formally through investment meetings and in writing. We try to put ideas in the Masters’ portfolios that we believe fit together well and provide excellent value.
We (our research team) use the same sources everyone else does: company financial reports, conference calls, meetings with company management, investment conferences, Wall Street analyst meetings and reports, trade shows and trade journals, and information we glean from industry contacts and from investors we’ve come to know over the years. The most important sources of information are analysts and money managers we’ve come to know over the years and whose judgment we respect.
The challenge is the same. We have the same issue in any investment portfolio — how do you generate the best long-term returns for shareholders given the parameters of the portfolio. The key difference in a concentrated portfolio is that the variance or tracking error from some benchmark is apt to be much larger than of one with more diversity. The chances are higher of much better or much worse or much more erratic results. This may be more of a challenge for us than for others because we focus more on slugging percentage than on batting average. Put differently, we focus more on how much money we make if we are right, not how often we are right. In a more concentrated portfolio, errors loom larger.
Neither the information contained herein or the opinions expressed shall be construed as an offer to sell or a solicitation to buy any securities mentioned herein. Click here to view the most recent portfolio holdings of the Masters’ Select Equity Fund. Click here to view the most recent portfolio holdings of the Masters’ Select Value Fund.
The Fund may invest in foreign securities, which exposes investors to economic, political and market risks and fluctuations in foreign currencies. The Fund may invest in the securities of small companies, which subjects investors to additional risks, including security price volatility and less liquidity than investing in larger companies.
The Fund is non-diversified, which means it concentrates more of its assets in fewer securities than a diversified fund.
To obtain a current prospectus for the Masters’ Select Funds at no charge, please click here or call 1-800-960-0188. The prospectus contains more complete information with respect to the risks, costs and expenses of investing in the Funds. Please read it carefully before investing.
 For industry terms and definitions, click here.
|
