Algorithmic Way

By Ramesh Akkineni

Bill Miller in a letter to TheStreet.com

Of course, in 1996, when we were buying Dell at $4.00 and trading at 6x with a 40% return on capital, no one thought we were being heretical. And when we were loading up on AOL at $15 in late 1996, people just thought we were nuts to buy something that was probably going out of business due to either the Internet, or Microsoft, or their own incompetence.
The issue of course is how can they be value now, with p/e's and p/book in the stratosphere?
Part of the answer has to do with general investment strategy. With money managers turning their portfolios north of 100 percent per year in a frenetic chase to find something that works, our glacial 11% turnover is anomalous. Finding good businesses at cheap prices, taking a big position, and then holding for years used to be sensible investing.
In a speculative market, long-term investing is rare, but it's what we do. We see no reason to sell a good business just because the stock price has gone up a lot, or because some amount of time has passed.
The better answer is that price and value are two different and independent variables. As Buffett has pointed out, there is no theoretical difference between value and growth; the value of any investment is the present value of the future cash flows of the business.
Value and growth do not carve the world at the joints; the terms are mainly used by consultants to allow them to carve the world of money managers up for clients. They represent characteristics of stocks, not of businesses. As Charlie Munger once said, the distinction is "twaddle."
With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me. Since a computer is not a scarce resource, and databases are not in short supply, accounting-based stock factors (price/earnings, price/book, price/cash flow, etc.) that the computer can identify and back test are unlikely to lead to robust performance.
Any combination of stock factors that appear to hold the key to outperformance will be quickly arbitraged away. There is no algorithmic way to outperform.
Any portfolio that outperforms over any length of time does so because it contains mispriced securities. The market was wrong about the future of that aggregate. We look directly for mispricings by comparing what the market says a company is worth with what we believe it is worth using a multifactor methodology.
This methodology starts with the accounting-based stuff and moves through private market value analysis, leveraged buyout analysis, looking at liquidating value, and of course involves a discounted cash flow model.
Valuation is a dynamic not a static process. When we first valued AOL it was trading in the mid-teens; we believed the business was worth $30 or so. We now value the business at $110 on the low end to $175, based on what we think is a conservative discounted cash flow. If we are right about the long-term economic model, the number could be much higher.
No one complains when we're loaded with General Motors or Chase—good, old, easy-to-understand values—or when we're buying perpetual dogs like Toys "R" Us or Western Digital in the midst of massive losses. It's the Dells and AOLs people object to. And what they seem to object to most is that we didn't sell Dell at $8 like other value guys did because historically PC stocks traded between 6 and 12x earnings, so when Dell hit 12x it must no longer be a value.
We are delighted when people use simple-minded, accounting-based metrics and then align them on a linear scale and then use that to make buy-and-sell decisions. It's much easier than actually doing the work to figure out what the business is worth, and it enables us to generate better results for our clients by doing more thorough analysis.
We own GM and AOL for the same reason: The market is wrong about the price because both companies trade at discounts to the intrinsic value of the underlying business.

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