Stock Gurus: Bill Miller

Legendary stock guru Bill Miller appeared on CNBC today. He manages a Legg Mason fund, and holds the record for beating the S&P (15 years), until the crash of 2008, that is. His portfolio has since rebounded as much as 40-80% (depending on what you’re looking at).

Mr. Miller is just behind Warren Buffet in the world of value investing. I respect his opinion, but like everything else, I think you have to keep things in perspective. For example, if you’re down 70% one year, and then up 100% the next year, you’re still down 35%. So don’t let these percentages fool you.

Also, you have to keep in mind that value players favor looking at valuation, which creates a bias. In Mr. Miller’s case, he may tend to underestimate the macro picture. I’ll give two examples. The first is real estate. Mr. Miller is long real estate and argued for a recovery. He’s down on that investment – he joked about being “early”. But oddly, no one on the desk of reporters (which is why I think it’s such a shame that reporters are asking questions) asked what happens when interest rates go up. Real estate will go down again, I believe, and how much depends on how much inflation there is. If that’s true, it means that he’s very early on real estate, the cycle isn’t over. On the same day, Professor Shiller of the well-known Case-Shiller Index admitted that there’s better than a 50% chance that real estate prices will go down again.

The other example lies in the 2008 crash. Mr. Miller didn’t see it coming, and that’s because he was looking more at valuation (price-to-book, PE, etc.) than at macro trends (in my opinion, he didn’t say that). In this interview, admitted that they’ve learned a lot. Before, he would have said that the depression scenario was off the table. Now, he has a different view: there are two different kinds of downturns – liquidity , as in 1987, when the Fed pumping money into the system was enough; and asset or balance-sheet downturns, where the value of assets decline and this is what the Great Depression was. This actually makes lots of sense. Consider the post dot.com period, when savings went down, but employment held up relative to 2008; and individual’s assets – such as real estate actually gained. In 2008, both savings and assets took a hit. So that’s a good way to look at it, I think.

Mr. Miller does think that there are still great values in the market, and of course, that’s the interesting part. He believes that the worst is over, but the recovery is far from complete. And the risk after a major event such as the 2008 crash is relatively low.

Mr. Miller’s example was IBM, which trades at 12x this year’s (2010) earnings. The company has top line growth of close to GDP levels, so not much exciting there. It’s the bottom line that’s interesting – it produces cash, so IBM buys back stock and earnings go up. It has performed consistently, even in this down market. I agree, lots to like there, especially for retirement portfolios.

Other picks include regional banks, that are trading at discounts to book value with good capital ratios; GE, Walmart, JP Morgan (with earning’s power of $6 or so, implying a $60 stock at 10x PE); Bank of America (with earning’s power of $3.50, implying $35 stock at 10x PE); JNJ, Pfizer; Merck and MGIC (which provides mortgage insurance, trades at about half of what it’s worth, and will someday make money in mortgages again).

I am long General Electric, JP Morgan and Bank of America.

July 14, 2009 – JNJ Earnings

The Results. Today, Johnson and Johnson reported the following:

- Revenue fell 7.4% to $15.24 billion from $16.45 billion last year. $1 billion of that decline was due to two drugs, Risperdal and Topamax, that came off patent. Sales of each of these drugs was down two-thirds or more. Excluding these drugs, sales would have been up $770 million, or 4.6%

- Earnings were $3.21 billion, or $1.15 per share, compared to $3.33 billion, or $1.17 per share a year ago

- The company confirmed its 2009 forecast of $4.45 to $4.55 per share, excluding items

Analysts expected $1.11 per share on revenue of $15 billion. As of 12pm today, the stock was up $0.28 to $58.

Other factors that impacted earnings included

- global recession

- unfavorable currency exchange rates, which cut total revenue by 6%

- Cuts in spending of 13% on sales, administration and research, and 6% in production costs

By product area, pharmaceuticals sales fell the most, by 13%; consumer products were up operationally, but down due to exchange rates, leading to a decline of 4.5%; and medical devices fell 3.1%. In consumer products, some sales were also affected by the switch to private label brands.

Recently, JNJ also made investments in Cougar Biotechnology for a prostate cancer drug and took a stake in Elan Corp for an Alzheimer’s drug. The FDA also recommended reducing dosage of Tylenol, a drug that brings in $1 billion a year for Johnson and Johnson. About half of the $1 billion is related to the extra-strength 500-milligram dose, the dosage that would be affected.

The Stock. Consensus estimates are $4.51 for December 2009 and $4.88 for December 2010. Based on today’s current price of $58.15, that would be 12.9x 2009 earnings and 11.9x 2010 earnings. Current estimates imply 8% growth year-over-year, and the current dividend is 3.4%.

Historically, the stock has traded in the 17-18x range in the last few years, and in the low to mid-20s before that. On a PE basis, JNJ is trading at historical lows.

There is no question that this is a quality company; its track record speaks for itself. Over the next year, we can expect the recession and currency issues to continue to affect earnings. Moreover, it may take some time for new drugs in the pipeline to boost sales. If JNJ hits its targets, we would have 8% growth plus a 3.4% dividend for a 11.4% return. To get a higher return, we’d have to see an expansion in the PE, something which may not occur this year, but is more likely to occur in later years as the economy rebounds and JNJ comes closer to harvesting its pipeline. So all in all, a respectable stock for a conservative portfolio, but don’t expect any fireworks soon.