Bill Miller, manager of Legg Mason Capital Management had an interview with Morningstar on June 25, 2010. He discussed a number of individual stocks that make strong investment case:
An excerpt from Morningstar.com.
Miller: Well, I don’t think they are going to get a much cheaper than they are today on a relative basis, moderately so, but not necessarily, dramatically so, but the ones that are the cheapest, we’ve already got them. There are other ones that are sort of sitting out there on the cusp, names like Wal-Mart, for example, that are very cheap historically. It’s hard to see how you don’t earn double-digit returns on Wal-Mart, but there are other retailers that are just as cheap or cheaper, like JC Penney, right now. So, Wal-Mart a little bit better quality, JC Penney cheaper, and that’s kind of the trade-off that we are looking at.
Hughes: So, as we look at maybe some more of those names, as you look at the portfolio today, who is the up-and-comer, what’s your favorite idea?
Miller: Well, I guess, the name that I find the most remarkably mis-priced name in the market is IBM. And the reason for that is that IBM I think is representative of what you can get in mega-cap in the U.S. And the reason I use IBM is, it’s been around a 100 years. So, it’s not like Google, which is relatively new or companies that you don’t have a lot of data. You have a 100 years of data on IBM. You have data on how the markets' valued and how it's behaved in various economic conditions.
Moreover, IBM is followed by everybody that follows big-cap tech. So, there is a large numbers of people looking at it and trying to figure it out. Maybe, most interestingly, IBM is one of the most transparent companies in the market. They tell you their long-term goals, they tell you their long-term expectations with respect to earnings per share, free cash flow, operating margins, dividend policy. And then they tell you the short-term, too, they gave you – they have already upped their guidance twice this year.
So, if you think about that the long history, the large numbers of people looking at it, and the company being very open, you would expect that if anything is going to be properly priced in the market, it’s going to be IBM. You should be able to earn excess return by buying IBM in the marketplace today. Yet, if you look at their results over the past five years, what you see is IBM has doubled their operating earnings per share in the last five years. The dividend has grown over 20% a year over the last five years. They've bought back stock and shrunk the shares outstanding every year.
This year, they will have record earnings and record operating margins again. They had that two years ago actually during the worst recession since the Great Depression. So, if they can navigate through that kind of an environment, when the economy has been arguably as difficult as it’s ever been, when the economy gets better, as is doing right now, they should do even better, which is why they have increased guidance twice this year.
Yet, you can buy IBM today at around 10.5 times this year’s earnings and around 9.8 times next year’s earnings, the lowest multiple it’s ever traded at, with returns on capital in the 25% to 30% range.
If you run it through any valuation model, it will show that it's 30% to 50% underpriced. Yet, nobody seems to care about it. In fact, when I mentioned it to other investors, they are like, 'I haven’t looked at IBM in a long time.' So, I think that’s the – it’s sort of like Poe's Purloined Letter, it’s hidden in plain sight.You can read the Morningstar transcript of the interview by following this link.
An excerpt from Morningstar.com.
Hughes:Can you really get those high-quality franchise names much cheaper than they are? I mean are you ever going to get them at a 40% discount?
Miller: Well, I don’t think they are going to get a much cheaper than they are today on a relative basis, moderately so, but not necessarily, dramatically so, but the ones that are the cheapest, we’ve already got them. There are other ones that are sort of sitting out there on the cusp, names like Wal-Mart, for example, that are very cheap historically. It’s hard to see how you don’t earn double-digit returns on Wal-Mart, but there are other retailers that are just as cheap or cheaper, like JC Penney, right now. So, Wal-Mart a little bit better quality, JC Penney cheaper, and that’s kind of the trade-off that we are looking at.
Hughes: So, as we look at maybe some more of those names, as you look at the portfolio today, who is the up-and-comer, what’s your favorite idea?
Miller: Well, I guess, the name that I find the most remarkably mis-priced name in the market is IBM. And the reason for that is that IBM I think is representative of what you can get in mega-cap in the U.S. And the reason I use IBM is, it’s been around a 100 years. So, it’s not like Google, which is relatively new or companies that you don’t have a lot of data. You have a 100 years of data on IBM. You have data on how the markets' valued and how it's behaved in various economic conditions.
Moreover, IBM is followed by everybody that follows big-cap tech. So, there is a large numbers of people looking at it and trying to figure it out. Maybe, most interestingly, IBM is one of the most transparent companies in the market. They tell you their long-term goals, they tell you their long-term expectations with respect to earnings per share, free cash flow, operating margins, dividend policy. And then they tell you the short-term, too, they gave you – they have already upped their guidance twice this year.
So, if you think about that the long history, the large numbers of people looking at it, and the company being very open, you would expect that if anything is going to be properly priced in the market, it’s going to be IBM. You should be able to earn excess return by buying IBM in the marketplace today. Yet, if you look at their results over the past five years, what you see is IBM has doubled their operating earnings per share in the last five years. The dividend has grown over 20% a year over the last five years. They've bought back stock and shrunk the shares outstanding every year.
This year, they will have record earnings and record operating margins again. They had that two years ago actually during the worst recession since the Great Depression. So, if they can navigate through that kind of an environment, when the economy has been arguably as difficult as it’s ever been, when the economy gets better, as is doing right now, they should do even better, which is why they have increased guidance twice this year.
Yet, you can buy IBM today at around 10.5 times this year’s earnings and around 9.8 times next year’s earnings, the lowest multiple it’s ever traded at, with returns on capital in the 25% to 30% range.
If you run it through any valuation model, it will show that it's 30% to 50% underpriced. Yet, nobody seems to care about it. In fact, when I mentioned it to other investors, they are like, 'I haven’t looked at IBM in a long time.' So, I think that’s the – it’s sort of like Poe's Purloined Letter, it’s hidden in plain sight.You can read the Morningstar transcript of the interview by following this link.
