By The Acquirer’s Multiple. Originally published at ValueWalk.
One of our favorite investors here at The Acquirer’s Multiple – Stock Screener is Bill Miller.
Miller is the founder of Miller Value Partners, and currently serves as the Chairman and Chief Investment Officer, and the Portfolio Manager for Opportunity Equity and Income Opportunity Strategy. Prior to Miller Value Partners, Bill and his partner, Ernie Kiehne, founded Legg Mason Capital Management and served as portfolio managers of the Legg Mason Capital Management Value Trust from its inception in 1982. Miller took over as sole manager in December 1990 and served in this role for the next 20 years.
As of December 2016 the Miller Value Partners had $1.87 Billion in assets under management (AUM).
Miller recently released his quarterly summary which included a piece on the importance of investing differently than everyone else if you want to be a successful long-term value investor. He says, “We really couldn’t care less if the immediate quarter was a little weaker, or stronger, than expected.”, when asked about the short-term future of Apple. Miller’s focus is clearly on the longer-term. It’s a must read article for all investors.
Here’s an excerpt from that article:
Opportunity Equity ended the quarter ahead, but it was a close call. We lagged in January, had a spectacular February then gave back some ground in March. We entered March nicely ahead of the benchmark for the year, but fell behind as the market lost ground. We made up all the lost ground plus some in the last few days of the quarter.
It doesn’t make much sense to squint at Opportunity’s (or the market’s) micro-movements as I’ve described. The only reason it’s worth writing about is to highlight two things: 1.) it’s not surprising for returns and excess returns to be delivered during narrow periods of time, which is why market-timing is so problematic, and 2.) our investment in RH (RH), formerly Restoration Hardware, helped propel the strategy’s advance at quarter end. The names that drove our return in the quarter tell an interesting story.
Judging from inbound questions in the quarter, people were most interested in Valeant Pharmaceuticals International (VRX) and Intrexon Corp (XON), our second and third biggest detractors from performance. Endo International (ENDP), which hurt performance the most, didn’t garner as much interest, which is most likely due to the fact that people view it as the less-maligned kid sister of Valeant. Together, these companies cost the strategy 281 basis points.
Gains in our two best performers, the Apple Jan 2018 $100 calls and RH, more than offset these losses since they generated 680bps of return. If you add in our third best performer (for a three name apples-to-apples comparison), Platform Specialty Products (PAH), the combined contribution grows to 817bps. Interestingly, we got few inquiries into these names. We did get many questions on Apple Inc. (AAPL) in the first half of last year when it was a laggard rather than a leader. RH was a new name in the fourth quarter of last year so it hasn’t yet gotten much attention. Both names illustrate why we think there are opportunities to generate solid returns in this market and why we think the current losers have the potential to become the biggest winners in the future.
Early last year, we had a call with a prospective investor who had many questions about Apple. “Don’t you follow their suppliers and know there’s channel weakness for the quarter?” We responded that while we did know that, it wasn’t a driver, or even a factor, in our investment decision. We really couldn’t care less if the immediate quarter was a little weaker, or stronger, than expected. Our positive view on Apple revolved around our view that Apple is a consumer brand, which implies much more durable earnings power than was implied in the stock.
When the stock hit $90 last May, it was trading under 7x what it was expected to earn the next fiscal year excluding net cash. In other words, the market was pricing it to shrink in perpetuity. We thought this was unlikely and the stock was a bargain. Apple released its new iPhone 7 in the fall, which reviewers panned as not innovative, yet sales exceeded nearly all estimates, which we think confirms our view of the brand’s power.
The stock is up more than $55 (over 60%) since that time, a whopping $288B increase in market value. After the big move up, it has been upgraded by many sell-side firms and every analyst has increased the price target. Buffett recently got involved in the stock adding to the enthusiasm. We like it less at higher prices than lower ones, but at 14x next year’s expected earnings, it is still cheaper than other consumer brands like Nike (22x) and Coca-Cola (22x).
To get different results than others, one needs to invest differently. Since the financial crisis, investors show significant risk aversion and seek low volatility. Additionally, they want immediate gratification, which is why we like to refer to this market as a “just in time” market. We do the opposite in both regards. We look for opportunities to make a significant amount of money and we are patient about when those returns will be earned. While we don’t aim to lose money on new investments, we understand that may happen in the course of positioning for long-term outperformance. When Apple traded at such a large discount to our estimate of intrinsic value, we bought more even though we did not know when it would rebound.
RH defies that typical trend and worked almost immediately for us. RH sells luxury furniture and home décor. It came public in 2012 at $24 after receiving buyout bids from numerous parties, including Berkshire Hathaway. It proceeded to perform well for 13 consecutive quarters as the stock made new highs, ultimately peaking at $106 in November 2015. The company made a number of changes in 2016 that hurt results. It suffered from inventory issues with its newly launched Modern line requiring costly customer accommodations, it delayed its major marketing book from spring to fall, it switched to a membership model from a more promotional one and it didn’t have the same level of Holiday merchandise.
Each of these items hurt results. However, it continued opening its larger format stores, which increase sales at least double from its smaller format stores. No one seemed to believe when the company insisted that many of the things that hurt earnings were temporary. It backed these words up with actions when it initiated a share repurchase that equated to ~30% of the market cap at the time, citing its undervalued shares. We believe RH is building the first scale high-end furniture company. We think the shares remain undervalued with potential earnings power of $10 per share over the long-term vs. a $46 current stock price.
On the other hand, Valeant and Endo have been some of our worst performers so far but we think that could soon change. Like RH, we don’t expect the stocks to turn around until the business fundamentals do. However, we think that could be soon.
Valeant recently hired a new CFO, Paul Herendeen, who’s very highly regarded. We, too, have been
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