The Legg Mason manager says this tech giant is like Poe’s ‘Purloined Letter’: Hidden in plain sight. Plus, Miller on gaining a behavioral edge in investing.
At the micro level, there is a very pertinent one right now, the oil spill in the Gulf. So that’s caused a huge amount of panic on the part of investors with respect to BP, Transocean, Anadarko and some other companies that have been involved in it. And all those companies have been sold off extremely harshly, despite there being very different underlying data-driven conditions. So BP is responsible for the spill. Anadarko is responsible for part of the spill under certain conditions, and Transocean is responsible for none of the spill and is indemnified by BP, but as a week or so ago Transocean was actually off more than BP was.
Hughes: So, as we look at maybe some more of those names, as you look at the portfolio today, who is the up-and-comer, what’s your favorite idea?
Miller: Well, I guess, the name that I find the most remarkably mis-priced name in the market is IBM. And the reason for that is that IBM I think is representative of what you can get in mega-cap in the U.S. And the reason I use IBM is, it’s been around a 100 years. So, it’s not like Google, which is relatively new or companies that you don’t have a lot of data. You have a 100 years of data on IBM. You have data on how the markets’ valued and how it’s behaved in various economic conditions.
Moreover, IBM is followed by everybody that follows big-cap tech. So, there is a large numbers of people looking at it and trying to figure it out. Maybe, most interestingly, IBM is one of the most transparent companies in the market. They tell you their long-term goals, they tell you their long-term expectations with respect to earnings per share, free cash flow, operating margins, dividend policy. And then they tell you the short-term, too, they gave you – they have already upped their guidance twice this year.
So, if you think about that the long history, the large numbers of people looking at it, and the company being very open, you would expect that if anything is going to be properly priced in the market, it’s going to be IBM. You should be able to earn excess return by buying IBM in the marketplace today. Yet, if you look at their results over the past five years, what you see is IBM has doubled their operating earnings per share in the last five years. The dividend has grown over 20% a year over the last five years. They’ve bought back stock and shrunk the shares outstanding every year.
This year, they will have record earnings and record operating margins again. They had that two years ago actually during the worst recession since the Great Depression. So, if they can navigate through that kind of an environment, when the economy has been arguably as difficult as it’s ever been, when the economy gets better, as is doing right now, they should do even better, which is why they have increased guidance twice this year.
Yet, you can buy IBM today at around 10.5 times this year’s earnings and around 9.8 times next year’s earnings, the lowest multiple it’s ever traded at, with returns on capital in the 25% to 30% range.
If you run it through any valuation model, it will show that it’s 30% to 50% underpriced. Yet, nobody seems to care about it. In fact, when I mentioned it to other investors, they are like, ‘I haven’t looked at IBM in a long time.’ So, I think that’s the – it’s sort of like Poe’s Purloined Letter, it’s hidden in plain sight.