NEW YORK (MONEY magazine) -
Bill Miller has a different notion of leisure reading than most of us do. Here's a partial reading list (brace yourselves, Grisham fans): "Art and Expression in the Age of Emerson and Whitman," "Wittgenstein's Place in Twentieth Century Analytic Philosophy," Shakespeare's "Othello" and "King Lear." Oh, and he wants to read some poetry -- perhaps "Paradise Lost," John Milton's tale of Satan's fall from grace.
Falling from grace is a concept that Miller can identify with -- at least in terms of investing results. A number of top holdings in the $9.1 billion Legg Mason Value Trust have suffered hellish plunges in value over the past year, with conglomerate Tyco International, which makes up 5 percent of the fund, down 75 percent.
But Miller, the only fund manager to outperform the S&P 500 for 11 years running, shows no sign of strain. If anything, he seems energized. Miller has leaped into the corporate-governance fray, calling for a ban on stock options and putting his money where his mouth is, rejiggering his portfolio to exclude companies, such as Starwood Hotels & Resorts Worldwide, that he feels aren't being responsive enough to shareholders.
The man who once pursued a Ph.D. in philosophy can, of course, offer a logical explanation for the market's recent behavior. Why hasn't the market responded as it normally does coming out of a recession and improved in line with the economy? Because it wasn't behaving normally when it went into the recession -- valuations were too high and still are, says Miller.
And if the market were to respond strongly by gaining 15 percent a year, say, for two years, well, then interest rates would rise as an offset. "Rates will basically keep valuations from rising, so the market can only rise in conjunction with earnings on a longer-term basis," he says. "S&P earnings should rise by 6 to 8 percent long term."
As Legg Mason's guru sees it, there is, in effect, a ceiling on the stock market. Miller points to General Electric, which trades at about 17 times 2003 earnings estimates. GE is plugged into the economy in many ways and has grown faster than both the broad market and gross domestic product.
It is a company where investors "can actually see the earnings, and GE raises its dividend and buys back stock," he says. "It represents the triple-A balance sheet. If it trades at 17 times earnings, nothing that you can actually trust is going to trade above that."
Dividends will become a key component of return, says Miller. If, as he expects, companies start awarding restricted stock -- stock grants with more strings attached than options -- he predicts a wave of dividend increases.
Stocks to watch: Miller
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One company that offers a healthy dividend is longtime Miller favorite Eastman Kodak. The pricing pressure on film is abating, and Kodak is the market leader in China, where use of traditional film is growing rapidly.
"Add a little bit of revenue growth, and you have explosive earnings numbers," he says. At $30, Kodak trades at about 12 times this year's earnings and 11 times estimated 2003 earnings, and Miller says its 6 percent dividend yield is secure.
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Miller's not expecting much in the way of dividends from another pick -- beleaguered Tyco. Miller thinks Tyco will regain investor confidence when it reports third-quarter earnings -- numbers that he expects to be "scrubbed nine ways from Sunday." As for corporate governance at Tyco, "we are highly confident that it will improve a lot, and as one of the largest shareholders, we'll play a role if they don't move in that direction," he says.
Miller praises management at USA Interactive, which holds stakes in Expedia and Hotels.com. It has "Warren Buffett-type characteristics" -- high free cash flow, a strong balance sheet and businesses that arbitrage the economics of various industries, Miller says.
And CEO Barry Diller, who is on the Washington Post's board of directors with Buffett, has said he'll issue fewer stock options and more restricted stock.