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Legg Mason's Miller Discusses Strategy

The famed fund manager says he considers his winning streak an accident of the calendar.


Legg Mason

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fund manager Bill Miller kept his winning streak alive in 2005. And in his fourth-quarter letter to shareholders he describes how he did it.

Well, almost.

Miller's $20 billion Legg Mason Value Trust fund returned 6% last year, beating the

S&P 500

by 1.1 percentage points. Miller's win enabled him to extend his dominance over the benchmark index to 15 calendar years.

But as Miller notes in his letter to shareholders, he considers his success less a streak than a "fortunate accident over the calendar," since the December-to-December time frame is the only one of the 12-month periods where his results have always outpaced those of the index. Moreover, Miller says his goal is less to preserve the so-called streak on a yearly basis than to construct portfolios that have the potential to outperform the market over three to five years without assuming undue risk.

"If we achieve that goal, we believe we will be doing our job, whether we beat the market each and every year or not," writes Miller.

In the letter, Miller describes himself as "valuation driven," explaining that the most common error in investing is confusing business fundamentals with investment merit.

"A company that is doing terrifically well, that has great management and returns on capital, and great products and prospects, may be a terrible investment if the expectations embedded in the current valuation are in excess of those fundamentals," writes Miller. "A company with poor business fundamentals, a mediocre management, and indifferent prospects may be a great investment if the market is even more pessimistic about the business than is warranted."

He also details his opinion on what many fund watchers describe as his contrarian style of stockpicking, saying that "systematic outperformance requires variant perception."

"One must believe something different from what the market believes, and one must be right. This usually involves weighting publicly available information differently from the market, either as to its magnitude or its duration. More simply, the market is either wrong about how important something is, or wrong about when that something occurs, or both," he writes.

Putting his philosophies into practice, Miller explains his approach to buying and holding one of his biggest winners, search giant


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, which comprises 3.6% of the fund's assets, according to Morningstar.

"Was Google good value at $85 when it came public? Well, it appears so, since it is now trading at $436 a year and a half later. But when it came public it was universally panned as another Internet hype stock with all the trappings of 1999's over-optimism."

"How about now, at $436? Is it worth as much as


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? The market says it is, at least on the basis of simple equity capitalization. How can that be? IBM's earnings are more than Google's sales. We owned Google on the IPO and we own it now. We own IBM, too."

Miller strikes a contrarian pose with another one of his holdings,


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. He asks if the company "should trade at a discount to the average company based on its price earnings ratio, despite having substantially better returns on its equity and a powerful global presence."

He asks a similarly contrarian question about



, which makes up just under 3% of the 41-stock fund. "Doesn't everyone know chemical-based film is going away? How could you own that? We are asked that all the time. We are Kodak's largest shareholder."

As to revealing the formula behind his stockpicking success, Miller says he has no secret, but he does illustrate some of the practices that differentiate his fund from others.

"Our portfolio contains a mix of businesses, some of which we believe are cyclically mispriced, and some of which we believe are secularly mispriced," writes Miller. "Our ability to properly price risk is our advantage."

Miller also says he "averages down relentlessly" and is "mostly inert when it comes to shuffling the portfolio around." Turnover has averaged in the 15% to 20% range at his fund, implying holding periods of more than five years, while other funds have turnover in excess of 100%.

"The combination of these three things means we manage money substantially differently from most other managers," writes Miller. "Different doesn't necessarily mean better, but it does mean different!"