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Cashing in on the undervalued

Mutual Fundamentals

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Step aside, mutual-fund managers, Ludwig Wittgenstein is back.

The ideas of the 20th century Austrian philosopher have helped win some of the most stunning mutual-fund gains during the current bull market.

"Impossible!" skeptics might say: Philosophers tend to shrink from the under-the-hood grunge work needed to shake down shareholder value.

But don a college gown, toss back the mortar board tassel, and meet William Miller, manager of the Legg Mason Value Trust (800-577-8589). With Mr. Miller there's no ivory tower, just pure ivory.

The former PhD philosophy student logged a 48 percent surge last year. He has beaten the Standard & Poor's 500 Index in each of the past five years with an average annual gain of 33 percent. So far in 1999, his mutual fund has returned 26 percent, compared to the S&P's 11 percent (as of 4/27/99). The fund's total assets have nearly tripled since early last year to $11 billion.

For all this high-octane performance, Mil-ler credits Wittgenstein, William James, and John Dewey for inspiring his "pragmatic" investment style. He spurns "preexisting notions about the right way to invest" and instead looks for business plans that "work."

That means Miller seeks value, nabbing companies with shining earnings potential overlooked by the market. In recent years, such an approach has taken a back seat to growth-oriented managers who focus on rocketship earnings with less regard for a stock's price.

But there's a twist to Miller's value investing. It helps explain why his fund has outpaced even leading growth funds.

Like most value managers, Miller sizes up stocks with yardsticks like price-earnings ratio or book value per share. But he goes further by estimating future free cash flow.

"A lot of times reported earnings are not a good proxy for free-cash generation because many companies are working-capital intensive," Miller says. "At the end of the day what the owner of a business cares about is what cash he can take out of the business."

Pursuing such forward-leaning value investing, Miller has seized on stocks classed as players in a go-go growth climate.

Three years ago, for example, he bought America Online and Dell, two of Wall Street's darlings. Since then the share prices have exploded 30 times and 40 times, respectively.

Miller also takes pages from the playbooks of Benjamin Graham, the grandfather of value investing, and Warren Buffett, the value-oriented "oracle of Omaha."


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