Value Stock Losers Buffett, Miller Poised as Winners (Update1)

By Michael Patterson and Eric Martin

Aug. 11 (Bloomberg) -- Bill Miller, Martin Whitman and David Dreman, mired in the worst slumps of their careers, are poised once again to trounce the stock market.

If history is any guide, the value investors' emphasis on shares trading at low prices relative to cash flow and earnings will provide returns superior to the holdings of so-called growth managers. Growth investing, which focuses on companies with the fastest projected profit increases, beat value strategies for the first time this decade in 2007 and by 15.5 percentage points so far this year, the widest margin since 1980, according to data compiled by Paris-based Societe Generale SA.

The five prior times since 1952 that growth beat value two years in a row, the latter group recovered and won by 17 percentage points annually on average for seven years, the data from Societe Generale show. Cheap stocks are becoming more attractive because of tumbling commodity shares, which had led the five-year bull market that ended in October, according to Societe Generale's James Montier, voted top global strategist in Thomson Extel's survey since 2005.

Value stocks became a liability as even Warren Buffett's Berkshire Hathaway Inc., the investment vehicle for the richest person in Forbes magazine's 2008 global tally, fell as much as 25 percent from a December record. Miller's Legg Mason Value Trust, which beat the Standard & Poor's 500 Index for 15 years through 2005, lost 27 percent including dividends this year, Bloomberg data show.

`Normally Snaps Back'

``This is one of the worst periods I've seen for value,'' said Dreman, 72, who oversees about $15 billion as chairman of Dreman Value Management LLC in Jersey City, New Jersey. ``The more it underperforms, the more it normally snaps back. The probabilities are very strong we'll have a major upswing.''

The flagship funds run by Miller, Third Avenue Management LLC's Whitman and Dreman are headed for their worst annual performances, data from Chicago-based Morningstar Inc. show, after subprime losses roiled financial markets and sent the S&P 500 into a bear-market decline of more than 20 percent from its October record. Omaha, Nebraska-based Berkshire had its steepest first-half drop in New York trading since 1990.

The investors' stock picks retreated as U.S. companies trading at the lowest prices relative to cash flow trailed the most expensive shares compared to cash flow by 15.5 percentage points in 2008, according to data compiled by Montier and Kenneth French, a finance professor at Dartmouth's Tuck School of Business in Hanover, New Hampshire.

Investments Gone Bad

That's the widest margin that ``value'' lost to ``growth'' on an annual basis since a 28-point gap in 1980 and follows a 4.5-point underperformance last year, Montier said in a July 30 report.

U.S. stock-index futures advanced today as higher oil and gold prices lifted commodities producers. S&P 500 futures expiring in September added 0.2 percent at 11:24 a.m. in London.

Miller, Whitman and Dreman adhere to the investment philosophy pioneered by Benjamin Graham, the late money manager and author of ``Security Analysis.'' Buffett, who attended Graham's Columbia University classes in New York in the 1950s, used the strategy to transform Berkshire from a failing maker of men's suit linings into a $179 billion company by purchasing assets he deemed cheap.

`Dismal Performance'

Berkshire declined this year as Buffett lost money from his stakes in Charlotte, North Carolina-based Bank of America Corp., the biggest U.S. lender by market value, and New York-based American Express Co., the nation's largest credit-card company by purchases. The stocks declined 22 percent and 27 percent, respectively. Buffett, 77, couldn't be reached for comment.

Berkshire posted its third straight quarterly profit decline last week as lower rates pressured results from insurance.

Miller's $9.7 billion Legg Mason Value Trust was dragged down by McLean, Virginia-based Freddie Mac, the U.S. mortgage- finance company hobbled by record foreclosures, and Arlington, Virginia-based AES Corp., a power producer with operations in more than two dozen countries. Investors fled, causing the fund's assets to fall more than 50 percent in the past year. The Massachusetts state pension fund fired Legg Mason last week, citing ``inconsistent'' returns.

``The best time to buy our funds or to open an account with us has always been when we've had dismal performance,'' Miller, 58, wrote in a letter to shareholders two weeks ago. The Baltimore-based investor said he's a ``long-term optimist'' even though ``valuation appeared not to matter'' in recent years.

Adding to MBIA

Whitman's Third Avenue Value Fund returned 958 percent from its inception in November 1990 through July, according to New York-based Third Avenue's Web site. The S&P 500 gained almost 500 percent, including reinvested dividends, during the same period, Bloomberg data show.

The $9 billion fund lost 19 percent in 2008 after Whitman added to his stake in MBIA Inc., the Armonk, New York-based bond insurer that tumbled 54 percent this year. Whitman, 83, couldn't be reached for comment.

Dreman lost 19 percent for clients in his $7.1 billion DWS Dreman High Return Equity Fund this year as Minnetonka, Minnesota-based UnitedHealth Group Inc., the largest U.S. medical insurer, slumped. The fund had outperformed the S&P 500 for seven straight years through 2006.

`Maintain Earnings'

Value may trail growth for another two years as more than $490 billion of credit market losses and asset writedowns at banks prolong the U.S. economy's slump, according to Bruce McCain, the head of investment strategy at Key Private Bank. He favors growth managers, who typically buy shares of companies that increase earnings and sales at a faster pace than peers.

``When you go into periods of slow economic growth, you need to shift your focus to companies that can maintain earnings,'' said McCain, 54, who helps oversee about $30 billion in Cleveland.

Richard Pzena, chairman of New York-based Pzena Investment Management Inc., said declines in commodity producers may prompt investors to switch into value shares.

``The momentum stocks get overdone, and the value stocks get so cheap,'' said Pzena, 49, who oversees about $18.5 billion. ``When it unwinds, the money flows from one direction to the other.''

The S&P 500 Energy Index slid 20 percent from its May record, while the S&P 500 Materials Index fell 17 percent from its peak. The plunge in technology, media and telecommunications stocks after the Internet bubble burst in 2000 led to seven years of value beating growth, according to Montier, 37, the London- based chief global equity strategist at Societe Generale.

``Investors should be a little bit masochistic and accept the pain of lagging,'' said New York-based value investor Jean- Marie Eveillard, 68, whose $24 billion First Eagle Global Fund beat 94 percent of its peers this year. ``They should resist the temptation to move.''

To contact the reporters on this story: Michael Patterson in London at mpatterson10@bloomberg.net; Eric Martin in New York at emartin21@bloomberg.net.