Tuesday, May 10, 2011

"Buy What's Out of Favor" - Bill Miller of Legg Mason


Good column in this morning's Financial Times from Bill Miller of Legg Mason.

Bill Miller, of course, is famous for beating the S&P 500 index for 15 years in a row. His streak ended in 2008, but he remains one of the best investors out there, and is always worth a listen.

Much of his piece today discussed commodities. Historically, writes Mr. Miller, returns from investing in commodities are cyclical, and he suspects that today will be no different. High commodity prices almost always reduce demand, making continued strong returns unlikely.

Bill Miller is a "value" investor, which means that he looks for opportunities in stocks and sectors that appear very cheap relative to both their growth prospects as well as their historic norms:

Where is the value in the market today? In the assets people do not want, that have no momentum, and that are cheap. Three broad sectors and two broad themes stand out. The S&P 500 sectors are: financials, technology and healthcare which are in the bottom decile of their historic valuation ranges. This means they have been more expensive 90 per cent of the time over the past 60 years or so. The themes are US mega cap, and deep value, meaning low price to book value and high free cash flow yield.

FT.com / Markets - A good time to snap up healthcare and tech stocks

In general I would agree with much of Mr. Miller's comments, although I am still nervous that there is "another shoe to drop" in the financial sector. Our financial sector remains clogged with huge amount of debt mostly related to housing that has yet to be recognized, and so valuation metrics might be slightly misleading.

Bank of America, for example, has already written off $17 billion in bad loans largely related to mortgage debt, and yet B of A CEO Brian Moynihan noted this morning that the banking behemoth has billions more in loans that have turned sour.

And as for tech: well, yesterday I posted a note on Microsoft, noting the huge pile of cash reserves the company is sitting on. Today the company is apparently going to use $8.5 billion of this cash hoard to buy Skype, the internet phone service. Given that Skype was valued at less than $2 billion a couple of years ago, I must confess that I am scratching my head on this one.