Bill Miller Q4 2006 Commentary: Discussing reasons for the 15 year streak.

Excerpts from Q4 2006 commentary of Bill Miller of Legg Mason Value Trust:

According to Bill Miller (BM) there were two fold reasons for his outperformance:
1. Security Analysis
2. Portfolio Management


Security Analysis:
BM highlights the following key factors related to security analysis:
1. Valuation is inherently uncertain, since it involves the future. However, in spite of this uncertainty, he states that 100% of the value of a stock is determined by its future (though this may be an exaggeration, as large number of asset play stocks have more than 50% of their value derived from their past, i.e., assets creation, which resides in their balance sheet)

2. According to BM, the market discounts whatever information is already available regarding the stock into its price (called as market efficiency). However, there are sometimes, when this ‘discounting’ may be optimistic, while other times it may me pessimistic, giving opportunities to create value for patient investors. BM tries to take advantage of such anomalies in his portfolio. Thus he buys things other people hate, like Kodak, or companies that they think will never conquer their problems, like Sprint. Sometimes it involves owning things people don’t understand properly, such as Amazon, where investors wrongly believe today’s low operating margins are going to be the norm for years.

Portfolio Construction:
1. BM constructs portfolio in a way that is defined in portfolio theories, i.e., on a risk-adjusted rate of return basis.

2. According to BM, a key reason for his streak has been factor diversification, which means he owns a mix of companies whose fundamental valuation factors differ. Thus BM portfolios have high PE and low PE, high price-to-book and low price-to-book. According to him, most investors tend to be relatively undiversified with respect to these valuation factors, with traditional value investors clustered in low valuations, and growth investors in high valuations.

3. According to BM, although funds are subject to requirements regarding diversification by industry or company, they do not have to be diversified by factor, that is, by PE ratios, or price-to-book, or price-to-cash flow. And it has been seen that they mostly are not: value funds tend to have almost all their money in low PE, low price-to-book or cash flow, and growth funds have the opposite. Thus, sometimes growth funds beat value funds and the market, as from 1995 through 1999, and sometimes value funds beat growth funds, as from 2000 through 2006, whereas BM funds which are factor diversified tend to do well in both markets.

Bill Miller's Legg Mason Value Trust Portfolio - December 2006

No.	Name	% of Net Assets
1	Tyco International Ltd.	5.2
2	The AES Corp.	5.2
3	Sprint Nextel Corp.	5.0
4	UnitedHealth Group Inc.	4.7
5	Amazon.Com Inc.	4.5
6	J.P. Morgan Chase and Co.	4.4
7	Google Inc.	4.4
8	Qwest Communications International Inc.	4.2
9	Sears Holdings Corp.	4.0
10	Countrywide Financial Corp.	3.5
11	Aetna Inc.	3.4
12	The DIRECTV Group Inc.	3.2
13	Yahoo! Inc.	3.1
14	IAC/InterActiveCorp	3.0
15	Citigroup Inc.	2.8
16	Eastman Kodak Co.	2.6
17	eBay Inc.	2.6
18	Time Warner Inc.	2.5
19	The Home Depot Inc.	2.3
20	American International Group Inc.	2.3
21	Health Net Inc.	2.3
22	Expedia Inc.	1.9
23	Pulte Homes Inc.	1.7
24	Hewlett-Packard Co.	1.7
25	Centex Corp.	1.6
26	Capital One Financial Corp.	1.6
27	Pfizer Inc.	1.6
28	Cisco Systems Inc.	1.6
29	Dell Inc.	1.6
30	Seagate Technology	1.6
31	Electronic Arts Inc. (EA)	1.6
32	General Electric Co.	1.4
33	International Business Machines Corp.	1.4
34	KB HOME	1.0
35	WPP Group PLC	1.0
36	CA Inc.	1.0
37	NIKE Inc.	0.9
38	Masco Corp.	0.6
39	Waste Management Inc.	0.4
40	Symantec Corp.	0.3
41	General Motors Corp.	0.1
Source: Legg Mason

Bill Miller – A Profile

Bill Miller is currently the Chairman & Chief Investment Officer at Legg Mason Capital Management, Baltimore, USA. Bill Miller joined Legg Mason in 1981 and manages the Value Trust and Opportunity Trust mutual funds. He was Legg Mason's Director of Research from October 1981 through June 1985 and assumed overall responsibility for the equity funds management area of Legg Mason in late 1990. Prior to joining Legg Mason, he served as Treasurer of the J.E. Baker Co. Bill graduated, with honors, from Washington and Lee University

in 1972 with a degree in Economics. He is on the Board of Trustees at the Santa Fe Institute, a leading center for multidisciplinary research in complex systems theory. Bill received his CFA designation in 1986.

He is a portfolio manager of the Legg Mason Value Trust mutual fund, the after-fee return of which has beaten the S&P 500 index for 15 consecutive years from 1991 to 2006.

Investment Approach:

Bill has often being criticized that he is a growth investor in the garb of a value seeker, as his portfolio is dominated by so called growth stocks like Amazon, Nextlel, etc. However, as he correctly puts it, he is literally a “Value Investor”, a long term patient investor (and not trader as can be seen from his low portfolio turnover) who seeks value (which he defines as a deep discount to his assessment of intrinsic value). According to Mr.Miller, intrinsic value is not judged simply by the book value or earnings per share (EPS), but by free cash flow generation, return on capital employed and long term sustainable high RoCE growth. This value changes with passage of time and hence the models of value also need to be changed peiodically, which can make a stock which was expensive two years back at the same price, a value buy today. Thus, the heart of Mr.Miller’s investment philosophy is the judgment of intrinsic value and then buying the business at a deep discount to such value.