A Talk with Legg Mason's Bill Miller

The manager of the Legg Mason Value Trust fund says he's looking for a bounce in big caps

For the first time since 1995, Bill Miller has been boosting his holdings in technology stocks for Legg Mason Value Trust (LMVTX). The fund manager with the near-incredible record of beating the market during each of the last 15 years says he recently bought Dell (DELL) and Hewlett-Packard (HPQ). The reason: He thinks they're cheap.

He's also betting that Internet stocks, which have dropped this year, are ready to turn higher as the seasonal weakness in the first quarter ends. Another one of his contrarian plays is homebuilding stocks, which have been selling off recently as evidence mounts that the housing market is softening.

BusinessWeek Online's Karyn McCormack recently spoke with Miller about his recent buys, top holdings, and market outlook. Edited excerpts of their conversation follow.

How are you positioning the fund? Have you made any changes recently?

We run the fund with a long-term orientation. We try to buy businesses that are cyclically undervalued due to the economy or specific to the company. We have no energy exposure. We've been increasing our technology exposure for the first time since 1995. We've went to 38% to 40% in tech.

We recently added Dell (DELL) and H-P (HPQ) to the portfolio. We think they're as cheap as they've been since '95.

We also added homebuilders, but we've bought a cluster of them, such as Centex (CTX), Pulte (PHM), Ryland (RYL), and Beazer (BZH). The biggest mistake people make in the markets is confusing the trend of fundamentals and the direction or attractiveness of stocks. Builders are just too cheap at six times earnings, even with housing weakening, which it undoubtedly is.

Why is your fund underperforming the market this year?

One thing that has hurt our results this year is we've been in the Internet group. We own Google (GOOG), eBay (EBAY), Amazon.com (AMZN), Expedia (EXPE), IAC/InterActiveCorp (IACI), and Yahoo! (YHOO) -- those are down 20% on average this year, so that has cost us about four percentage points of return. We think they're ready to turn. Fundamentals are strong, valuations are attractive, investor interest is low, and the stocks have exhibited a seasonality in the last few years of weakness in the first quarter and strength in the second.

Google is down 130 points from the high, trading [on Mar. 20, at $348] at around 29 times the consensus estimate for 2007. We think that's a very attractive multiple.

We also have a very large weighting in the managed-care stocks, like UnitedHealth Group (UNH), Aetna (AET), and Health Net (HNT). UnitedHealth is our second largest position and is down about 12%. HMOs did so well last year and the growth rate is slowing, but not dramatically. The combination of those two sectors and no energy has hurt.

What are your top holdings?

Our top names bounce around as the stock prices move. Our largest holdings are Sprint Nextel (S), UnitedHealth, Tyco (TYC), Aes (AES), Amazon.com, J.P. Morgan (JPM), Qwest (Q), Google, and Eastman Kodak (EK).

Why do you like Kodak?

It's in the midst of a broad transformation to a digital company. We think it has the best portfolio of products. It bought software company Creo [a supplier of pre-press systems used by commercial printers]. Commercial printing is going from analog to digital -- that's a monster market. It has a lot of patents in this area, especially for high-quality digital output.

The stock has surprised people -- it's up 27% this year. We've owned Kodak for several years, and added to our position in the fourth quarter. We're by far the largest shareholders, and own 25% of the company (see BW Online, 1/31/06, "Kodak's Comeback: Still Undeveloped ").

What should investors be watching?

We're watching for when the Fed stops tightening at either 4.75% or 5%. The second thing is multiple compression -- we've seen this stop with the end of tightening cycles. The market is already up 4.6% this year, and it could be on track to be up 25%. Now, it may not be up that much, but we certainly see the market up in the double-digits.

We think the market will be led by big cap names. People always tend to do today what they should have done five years ago. People should have been buying bonds, REITs, and energy and should have been selling large caps and tech. What's popular now is energy, emerging markets, REITs, bonds -- all the stuff that had been down five years ago. What has been the worst for the last five years is large caps and tech. We think the action is in tech and big caps -- that's where the valuations are most attractive.

Which book would you recommend for investors?We have all of our analysts read Bill Poundstone's book Fortune's Formula (Hill and Wang; September, 2005) -- it's the best book on investing since Moneyball (W.W. Norton & Company; May, 2003). He adapts Claude Shannon's work on information theory and tells how to maximize your return (see BW Online, 9/26/05, "Get Rich: Here's the Math"). I highly recommend it.

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