It's Miller time ... again. Manager Bill Miller and assistant
manager Samantha McLemore run $1.8 billion Legg Mason Opportunity
, which soared 68.03% in 2013. That was '13's top-performing
diversified, nonleveraged U.S. stock fund, with more than $200
million in assets, according to Morningstar Inc.
Just like old times. Starting in 1991, Miller's Legg Mason
Value Trust topped the S&P 500 for 15 years in a row.
The fund's winning streak derailed in 2006 due to bad bets on
housing stocks and other sectors. Miller gave up that fund's
tiller in April 2012. He's been a manager of Opportunity since
Dec. 30, 1999. McLemore arrived Aug. 19, 2008.
They're building a new winning streak. It has outperformed its
midcap value category and the S&P 500 for five quarters in a
row, including Q4.
Miller, age 63, and 33-year-old McLemore talked with IBD from
their quarters in Baltimore.
How does this fund's approach differ from Value Trust's?
Value Trust is a large-cap value fund, whose objective is growth
and capital appreciation.
This fund is unconstrained regarding asset class and size. The
idea is to have a fund that can migrate, that can own bonds and
other sorts of things.
And are all of this fund's buys of stocks that are
Our favorite thing is to buy businesses that are under distress.
That's when the perception of their risk is most distorted. I
would guess probably close to two-thirds of our buys are close to
their 52-week low or have done poorly when the market's done
well. We're not restricted to that, but the chance to buy values
is better then than when something is on a high list.
Give me an example, please.
) pulled back, we added to that. I don't know if you'd consider
that distress. We think the fundamentals are solid, but the stock
had come down.
In 2008 the fund lost 65.5%. What changes in approach have you
made since? For example, do you wait for a stock to show signs of
a turnaround before buying?
Oh, absolutely! We're not doing illiquids. Lesson No. 2, we're
much quicker to put in hedges.
And we're paying attention to rising vs. falling correlations.
If we see correlations rising (among our holdings), we move
quicker to things that hedge against that.
What other steps do you take?
When fundamentals weaken, we're quicker to exit.
Will the housing rebound continue as rates rise?
Yes. Curt Culver, the CEO ofMGIC (
), says we're heading into housing nirvana.
We had six years of decline from the peak. Interest rates went
down. Since the housing cycle turned up, rates are up. So are
stocks. So low rates were not good for housing stocks because
fundamentals were so bad. Since the housing cycle turned (up) in
2012, rates are up. So are stocks. Not up (in 2013), but up a ton
In 2012 the builders --Pulte (
),KB Home (
) -- were up triple digits, most of them. (In 2013 they were)
flat to down. The ones that didn't do well (in 2012) -- like MGIC
andeTrade (ETFC), which has a large mortgage portfolio -- (were)
up triple digits (in 2013).
So we're bulls on the housing cycle. Rates are likely to
continue higher. But housing stocks, direct builders, after a
pause (last year) will have a great 2014.
Where doesEllington Financial (EFC) fit in?
They're less of a direct housing play. They operate in
mortgage-backed securities and agency securities. They're really
a hedge fund trying to maximize income and grow book value
through investing in housing securities, but they can go long and
Best Buy (BBY) earnings per share skyrocketed 350% in Q3, but the
stock sold off. Are you concerned too?
The story is that since the new CFO (Sharon McCollam) came in
from Williams-Sonoma, they've done a fantastic job. They are
trying to train associates so they are knowledgeable and not
trying to rip off customers by steering them to things like
insurance for televisions.
People were afraid a year ago thatAmazon (AMZN) would put them
out of business. Now they've realized that same-store sales have
started to turn positive again. The company can be profitable
even as Amazon prospers.
It sold off recently because people expected a big margin
improvement in the near term. We expect it in the next year or
I see several airline stocks in the portfolio. Is there a
consolidation play, or some other strategy?
There is consolidation. Three of our top holdings are airlines.
(The three includedDelta Air Lines (DAL) andUnited Continental
(UAL) as of Sept. 30;US Airways has since merged withAmerican
Airlines (AAL).) The industry is reporting record profits. And
we're early in the industry turnaround. Delta has done the best
because of dividends and buybacks. But airlines are trading at a
huge discount to cruise line stocks and shippers likeFedEx (FDS)
andUPS (UPS). So we think there's a lot of room to go with
United is our favorite. United and Delta have roughly the same
revenues and their balance sheets are similar once you adjust for
things like capital leases and pension liabilities. But Delta has
a $25 billion market capitalization and United has $14 billion.
United has 14,000 more employees and 500 more planes.
United will be rationalizing that in the next couple of years,
so we see significant margin (improvement) opportunity there. And
United will start returning capital to shareholders, which should
help the stock as well.
IsIAC/InterActiveCorp (IACI), which has begun to run up, a play
on its wide portfolio of Internet sites?
This is just a small position for us. It has run up (recently)
because it might spin off disparate subsidiaries. But it's more
the case that at about six times enterprise value vs. EBITDA that
we bought it, it was way too cheap given the value of its
underlying assets. (In the past,) CEO Barry Diller has spun off
Home Shopping Network,Expedia (EXPE) andTripAdvisor (TRIP). He's
a value creator.
There are a lot of assets that could be spun out. We bought it
around 50 when we thought it was worth 70 (and it has gapped up
to around 70).
Netflix (NFLX) is uptrending, but you've trimmed in recent
quarters. What's your thesis?
When the company talked about splitting in two, it caused
subscribers to flee. The stock went from over 300 to the low 50s.
It was earning over $5 a share on its U.S. business alone. It was
hard to believe a company of that dominance would trade at 10
times earnings while it was growing 20% to 30% a year.
What was causing the angst was the money it was spending
internationally. (The fund started to buy around 50.) The company
looked like it was worth two to three times what we were paying.
Then (activist investor) Carl Icahn got involved. The stock
started running up rapidly. Now its valuation is similar toSirius
' (SIRI), but Sirius has greater free cash flow and more
predictability. The valuation on Netflix properly reflects its
current trajectory of growth but one that may not reflect its
total addressable market. We've cut back a fair amount, but it's
still a 3% position.
Apple has sold off a little since late last month, but basically
has uptrended since June. Investors love it or hate it. What's
Apple is fascinating. Every person in the market has an opinion.
Usually about 90% are tilted to what's the next hot product.
Usually the opinion is tilted to what's their next hot product.
Can they still be innovative? Will they have an iWatch? Are they
going to be in TVs? The questions are interesting but irrelevant
when Apple was trading around 400 a few months and around 550
now. They're still cheap.
They have $45 billion of free cash flow and a $300 billion
market cap, with $150 billion in cash on their balance sheet,
making the biggest buyback in the history of the world, and with
a dividend yield over 3%.
We sold in the 650 to 700 range a year ago as it was peaking.
We thought it was near fair value.
Since then we've seen that its historical trading pattern was
trading on earnings estimate revisions. And it was peaking at the
time and began to fall. We calculated that earnings revisions
would bottom in the beginning of Q2 and into Q2 as they announced
new products like the iPhone 5 and a refresh on their iPads. That
In the past few months earnings estimate revisions have turned
higher. So price targets have turned higher. The stock has turned
higher. We think Apple is worth 750 to 800 a share. Will it get
there? Maybe at some point, but it's still cheap vs. its
IseTrade (ETFC) a plan on the U.S. economic rebound?
It's within 10% to 20% of fair value. It had a huge move, which
was driven by the correct perception that its mortgage book is
When the stock was at 9 or 10, we thought it was worth about
18. That was with big losses in the mortgage portfolio mark to
Etrade has three things going for it: First, if the Fed starts
putting rates up, that'll lead to earnings estimate increases.
Second, as individual investors come back to the market, they
service them. Third, they're a consolidation candidate
viaAmeritrade (AMTD) orSchwab (SCHW) or somebody like that.
IsMorgan Stanley (MS) a similar play?
What you see is what you get. CEO James Gorman has been
transparent that the company needs return on equity higher. And
they can do that by combining their sales force with Smith
Barney's, which is now under way.
We bought back in the teens when the stock was trading way
below tangible book value. Now it's trading above tangible book
value, but not much. Earnings estimate is trending higher.
They're a beneficiary of a higher return on equity leading to
rising relative price-to-book. And as capital markets improve,
they benefit from that. But they're nowhere as cheap as they were
when they were trading at a big discount to tangible book.
Citi (C) is still a discount to tangible book.Genworth (GNW)
is a huge discount to tangible book. So there are still names out
there that have a lot of improvability left.
A lot of investors are turned off byAmazon's (AMZN) dismal
earnings per share record. Why aren't you?
Miller: Our average cost is 5.84. Now shares are pushing 400.
They have an almost insurmountable sustainable cost advantage in
the retail space. They also have Amazon Web Services, a business
in the cloud computing space, where it's also a leader. And
they've said (it will be) at least as big as their retail
business. Their total business is $75 billion, so AWS might be 5%
to 10% of that.
Amazon reminds me of the old telecom TCI under John Malone.
Malone is one of the great value creators in all of American
business. A dollar invested with him when he took over TCI, when
he sold it 25 years later toAT&T (T), was worth $900. A
dollar invested in the S&P 500 was worth $22.
My point is that Amazon has a tremendous record of creating
value for shareholders since it came public. Malone never
reported a profit with TCI. But he built tremendous value. We
think Amazon should not report profits. They should grow the
business as fast as they can to sustain their competitive