Bill Miller used to be a rock star of the value investing world. Between 1991 and 2005, he beat the market every single year managing the Legg Mason Value Trust.
Unfortunately, his record fell apart after 2005. The smaller Legg Mason Opportunity Trust, which he also managed, lost the majority of its investors' money between the end of 2006 and the end of 2011. For every $10,000 invested, investors got back just $4,815 due largely to Miller's mistimed bets on financial stocks.
Miller left Legg Mason in 2016 and went on to start Miller Value Partners, which he runs today.
Miller today
Judging Miller's record based on his past successes is difficult. Yes, he managed to beat the market between 1991 and 2005, but a large percentage of this period was dominated by two of the greatest bull markets of the past century. When value should have outperformed -- during the financial crisis -- Miller struggled.
I wanted to highlight some recent comments Miller made about the most prominent mistake value investors are making today. He believes investors are concentrating too much on companies trading at low prices and low valuations. With a history of investing in Amazon (AMZN, Financial) and Netflix (NFLX, Financial) in the early days, it seems Miller has a record of finding not just undervalued equities, but future growth stocks as well.
According to CNBC, he recently acquired a stake in social media network Facebook (FB, Financial) after its data scandal surfaced. Miller said he was able to buy the stock at just 14 times expected 2019 profits.
The reason why he's been buying FANG stocks is he believes there's more growth in these companies than investors are giving them credit for. Miller believes value investors are concentrating too much on valuation and are not conducting a proper analysis of the underlying business, which means they are missing key points:
"To the extent that value is based on a simple calculation about ratios, that's a very simplistic definition of value. If people are buying things, they haven't analyzed ... it's not likely to end well."
According to CNBC, Miller also likes Amazon because it has "always has been able to maximize cash flow (including operating cash flow topping $25 billion in the 12 months through March) and has used its cash to grab the early leadership position in the cloud computing business. That business is fast growing — making Amazon look like a growth stock — but it's also highly profitable, making Amazon attractive to value-oriented investors even now."
The Miller approach
Miller is right to a certain extent; value investing is not just about finding the cheapest stocks. It is about finding companies that look attractive on many different factors, including evaluation and growth potential.
In many respects, this is similar to the investment approach Warren Buffett (Trades, Portfolio) uses. Buffett is more than happy to buy companies trading at what would generally be thought of as expensive valuations by the value community, though he's looking at more than just the price-earnings ratio.
While Miller's comments do make sense, there is a reason why we use valuations; because it gives us a quick idea of how overvalued or undervalued a business is compared to the rest of the market. Also, historically, buying at a low valuation has generated the best returns for investors, as well as building a margin of safety into our estimates of intrinsic value. Miller might have his own methods of calculating intrinsic value, so I cannot write off his approach. That being said, the majority of the data points to the conclusion that using a valuation-based approach, and buying stocks trading at a low valuation, is the best way to generate market-beating performance over the long term.
It is interesting food for thought. The one primary takeaway from this interview, however, is that investors should focus on detailed research and not just take valuations at face value. Thorough analysis is the only way to reduce risk.
Disclosure: The author owns no stocks mentioned.
