STOCK IDEAS
Start Your Streak Today

By David Meier
November 17, 2004

This is the year of the streak. The Boston Red Sox broke their 86-year World Series drought. Jerry Rice's streak of catching a pass in 274 straight games ended. And the New England Patriots finished their winning streak at 20 games in a row. All we need is a remake of Ray Stevens' crazy song "The Streak" to round out the year.

For Fools, Legg Mason Chief Investment Officer Bill Miller's streak of beating the S&P 500 index is the one to note. Amazingly, his Legg Mason Value Trust fund has outperformed the index 13 years in a row. And since Miller will likely have to start a new streak (the fund is down about 4% relative to the index as of November 4, 2004), I think it's a great time for us to start one, too.

How are we going to do it? Great question. We'll start with four key things I took from Janet Lowe's biography of Miller, The Man Who Beats the S&P. So if you're ready to go, grab your glasses and read on.

Tenet 1: It's a business, capice?
From The Man Who Beats the S&P, we learn that Miller never loses sight of the fact that a stock is partial ownership in a business. I can hear you now, "Wow, that's stating the obvious." But you'd be surprised how many fools don't know a thing about the businesses behind their stocks.

Do I know how Google (Nasdaq: GOOG) generates revenue? Do I know if its competitive advantage is sustainable? I think I get the gist of it, but I have not studied Google enough to completely understand it. As a result, Google is not a business in which I am ready to invest.

Do I understand how Nike (NYSE: NKE) works? I believe I do as I took the time to learn as much as I could before I started trying to analyze its value.

The most important chapter in the whole book is entitled "Numbers Are Not Enough." It stresses that before we get carried away with calculating numbers, we have to know how the business works to understand what the numbers mean. And knowing what the numbers mean is the prelude to Tenet 2.

Tenet 2: Valuation, valuation, valuation
Only when we understand how a business works can we estimate its value. If we do not know how a business creates value, how can we estimate its worth?

For example, a recent pick in one of US newsletters was Mattel (NYSE: MAT). I have to admit that my first reaction was one of skepticism. But the analysis pointed to the value drivers that showed why Mattel's market value was below its intrinsic value. Understand that price is what you pay for a stock and value is what you get. So regardless of whether we're looking for growth, value, or income, we have to determine a price we are willing to pay.

Tenet 3: Focus
If you take the time to learn about a business and make an estimate of its value, you have an advantage over others -- the ability to focus your investments. All money managers have to diversify their portfolios. But the great ones focus on a few outstanding opportunities and make big bets. Below is a table to illustrate my point.

We all know about Warren Buffett's huge stake in Coca-Cola (NYSE: KO). We see that famous fund manager Wally Weitz owns 17.2% of mortgage real estate investment trust Redwood Trust. And Bill Miller focused a large part of Legg Mason's portfolio on independent power producer AES. I would recommend that you look at the charts for these companies to see if these big bets have paid off.

Other successful businessmen use focus in their portfolios, too. Namely insiders who manage the businesses they created. Focus creates wealth.

Tenet 4: Push the envelope
The last, and most interesting, thing to take away from Bill Miller is his willingness to push the envelope. Miller has taken the time to learn how to value businesses that most traditional value investors wouldn't touch with a 10-foot pole. In fact, many questioned whether he really was a value investor when he bought stock in Amazon.com (Nasdaq: AMZN) and AOL (before the merger with Time Warner).

Finally though, a word of warning. You can't beat the market every day. It's about using our tools and picking the right opportunities. Trust me, you can do it.

The Stock Ideas series consists of articles originally published on our US site, Fool.com.