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Course 510
Great Investors: Bill Miller

Introduction

Bill Miller is not your typical value investor. Known for his phenomenal track record as manager of the Legg Mason Value Fund LMVTX, which beat the S&P 500 index for nine straight years in the 1990s, Miller's stock-picking style defies conventional wisdom. Whereas traditional value investing teaches that stocks should be evaluated on price, Miller argues that stocks should be evaluated by the worth of the underlying business. Some value-investing enthusiasts disagree that Miller is one of their own. While his practice of valuing stocks on the underlying businesses is acceptable, Miller has made some questionable "value" plays--continuing to hold on to America Online AOL and Dell Computer DELL in 1999, for example, even though both stocks had made substantial price gains since he bought them. Critics characterize Miller as a growth investor in value clothing. Here's how the iconoclast invests.

Start with Low Prices

Like any value investor, Miller begins by screening for stocks with low price multiples. That's how he found Dell. He bought shares of Dell back in 1996 when the computer maker's shares were getting beat up by the competition and trading for a measly six times earnings. By the end of 1999, Dell's valuation was twice that of the average computer maker: It traded for 60 times earnings, versus an industry average of about 30 times earnings.

Determine Fair Value

But Miller doesn't rely solely on price multiples to determine whether a stock is a good value. He also calculates what he calls a company's fair value. In order to attach a value to a business, Miller dissects companies based on how they derive revenues, then values each part separately. With AOL, for instance, he dissected the company based on the three ways that it makes money: user subscriptions, ad sales, and transactional sales (such as the sale of AOL goodies). He then measures each piece of the business against what he calls a peer industry. For example, Miller matched up AOL's user-subscription business against that of the typical cable company, which derives its revenues in similar ways. After he values each portion of a business separately, he then adds the values together and divides the sum by the number of outstanding shares to determine a company's worth per share.

Constantly Reevaluate Fair Value

Any other value manager would have sold Dell and AOL in 1999, but Miller continued to hold both stocks. That's because he treats a stock's fair value like a moving target that should be reassessed with the ebb and flow of market conditions. Miller held on to Dell and AOL despite their egregious price/earnings multiples because the stock prices were still below the fair value target. Miller buys like a value investor, but he sure doesn't sell like one. While Miller's "value" argument may not jibe with the most conservative of value investors, it does present a convincing argument for the notion that value stocks come in a variety of shapes, sizes--and price multiples.

Quiz 510
There is only one correct answer to each question.

1 On what premise does Miller evaluate a stock?
a. He evaluates a stock based on the value of its underlying business.
b. He evaluates a stock based only on its price/earnings ratio.
c. He evaluates a stock based only on its price/book ratio.
2 How does Miller calculate a stock"s fair value?
a. He traces the stock"s history back to its lowest price ever and considers that price the stock"s fair value.
b. He dissects a company according to how it makes money, and then he values each part of the company separately.
c. He divides a company"s sales by its outstanding shares of stock.
3 How does Miller"s portfolio differ from those of other value investors?
a. He tends to buy stocks with lower price/earnings and price/book ratios.
b. He trades more often.
c. He tends to hold onto stocks with high price/earnings and price/book ratios.
4 What summarizes Miller"s philosophy about a stock"s fair value?
a. A stock"s fair value isn"t static.
b. A stock"s fair value is constant.
c. As long as a stock is in a slump, it"s fairly priced.
5 When does Miller sell a stock?
a. When its price/earnings ratio rises above his target.
b. When its price/book ratio rises above his target.
c. When its stock price rises above his target.
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