Below is Part 3 of a five-article write-up regarding legendary investor Bill Miller, CFA, during the 2006 Financial Analysts Seminar, hosted by the CFA Institute. In this installment, we compare Miller's style with that of another legendary investor, John Neff, CFA, who also spoke at the conference.
Not your father's value investor
Though some believe that Bill Miller's style is very different from John Neff's, it is actually the same in many respects. Much like Neff, Miller described the term "value investor" as a misnomer. In one respect, Miller can be considered a value purist (very Foolish!), in that he believes a company's value is determined by discounting its future free cash flow back to the present, also known as discounted cash flow (DCF). However, he surmised that most "value guys" place a greater emphasis on market-comparable methods such as P/E (price to book), instead of performing the more theoretical exercise of creating and calculating a DCF.
His main point of contention -- perhaps the key to his stellar track record -- is that he believes that most value investors place too much emphasis on valuing the past business versus focusing on how a business will perform in the future. Decoupling the past from the future and focusing on what could reasonably be expected to happen is what Miller stresses to his fund management team. For instance, does Tyco's (NYSE:TYC) checkered past or Hewlett-Packard's (NYSE:HPQ) former management team imply the same difficulties in the businesses going forward? Apparently, Miller doesn't think so.
A current stock idea
Pfizer (NYSE:PFE) CEO Hank McKinnell and his management team recently stopped by to visit Miller's team. Miller has been underweight pharma for a number of years because of a weak R&D pipeline, among other things. But his interpretation of McKinnell's discussion was that Pfizer was becoming more upbeat about its R&D productivity. For example, the number of drugs progressing from phase 1 to phase 2 trials had increased from 40% to an estimated 70%, according to management. As a case in point, Miller noted that Pfizer recently increased guidance and referenced its pipeline. He saw this turn of events as even more noteworthy, since the lower-margin consumer business was just sold to Income Investor pick Johnson & Johnson (NYSE:JNJ). According to his projections, Pfizer possesses a 14% implied rate of return, versus an expected average market growth rate of 7%.
Dividends
In contrast to Neff, Miller sees dividends as an unfavorable form of shareholder returns; according to his team's estimation, they are generally reinvested back into the market and earn, on average, only the market rate of return. While he does look at dividends, Miller said he may not be interested in a firm if it announced a big dividend increase, because that could imply that management is finding it difficult to locate compelling internal growth avenues. As he stated earlier, Miller's approach to investing is more focused on estimating the firm's growth in future cash flows over time -- though he did admit that a steady dividend policy could enhance management discipline.
Stock repurchases
Miller does not believe in blanket or systematic company stock repurchase programs. Instead, he recommends that companies investigate the rate of return and repurchase shares only if the stock is undervalued. He didn't agree with Dell (NASDAQ:DELL), when it repurchased its stock back near $40 per share, but the company's situation is clearly different today. He applauded management's repurchase of nearly 3% of its outstanding shares last year, and pointed out that founder Michael Dell is also buying shares today, even with an already substantial holding.
Free cash flow
When asked if he was interested in a company's quality of earnings, Miller responded that he does believe quality is important, but instead of relying on earnings, he focuses on a firm's free cash flow generation. As a follow-up, I asked him how he and his team calculate free cash flow. He replied that the most important thing is to consider how the company's owner would run his business, and calculate free cash flow accordingly. Though he didn't provide specifics, he stated that his team does make adjustments when calculating free cash for the companies it investigates.
Tyco and Pfizer are Inside Value picks. Dell is both a Stock Advisor and an Inside Value pick. How many winners have you picked lately? Talk stocks with other investors and our analysts when you give our newsletters a try.
There's lots to learn from Bill Miller, so be sure to check out Parts 1 and 2 .
Fool contributor Ryan Fuhrmann is long shares of Pfizer, but has no financial interest in any other company mentioned. The Fool has an ironclad disclosure policy. Feel free to email Ryan with feedback or to discuss any companies mentioned further.
