It isn't a secret that Bill Miller's performance was disappointing during the past five years. However, we like his recent picks. Bill Miller is retiring from Legg Mason's flagship fund Value Trust but he will manage Legg Mason's Opportunity portfolios which have around $1 billion in assets. He will also remain chairman. The changes will be fully in effect by April 2012.
Legg Mason's portfolio is tilted toward the technology sector which is undervalued according to our calculations. About one-fourth of Legg Mason's portfolio is invested in the tech sector. As of December 31, 2011, three out of Legg Mason's top six positions were tech stocks. In this article we will focus on Bill Miller's top stock pick, Apple (AAPL), and its main victim Microsoft (MSFT) which is significantly affected by Apple's latest innovations.
Apple is the largest position in Legg Mason's portfolio. At the end of last year, Legg Mason had $221 million invested in this stock. AAPL is the most popular stock among hedge funds (see the 10 most popular stocks). At the end of December, more than one-third of the funds tracked by us reported to own AAPL. Besides Miller, Tiger Cub Stephen Mandel and Chase Coleman were also bullish about AAPL.
Apple returned 53.4% over the past 52 weeks, beating the market by nearly 50 percentage points. We think it will continue to be a winner in the future. The company is a leader in its industry. It designs and sells products that are welcomed by consumers. We are optimistic about its products, such as iPad, iPhone and MacBook. We think these products will achieve more market penetration globally in the next few years. Additionally, AAPL is very attractive when it comes to valuation. It has a 2012 forward P/E ratio of 12.7 and its EPS is expected to grow at 18.76% annually over the next five years. Therefore, its forward P/E ratio for 2014 is about 9, compared with 7.4 for Dell Inc (DELL) and less than 6.0 for Hewlett Packard (HPQ).
Many tech giants have appealing valuations. Our second favorite Legg Mason tech stock, Microsoft, is also trading at low multiples. At the end of last year, Legg Mason reported owning $145 million worth of MSFT shares. MSFT's 2012 forward P/E ratio is 12 and it is expected to grow at an average of 9.2% per year over the next five years. So its 2014 P/E ratio is about 10, lower than the market and most of its peers.
Other tech giants - Google Inc (GOOG) and Oracle Corp (ORCL) - also have very attractive multiples. GOOG's 2014 P/E ratio is 12 and ORCL's is 10.2. We actually like all these technology stocks. Investors value utility stocks at 13-14X their earnings whereas tech stocks that grow at much higher rates are valued at as much as half of these multiples. We think tech stocks are undervalued as a sector and have great potential to generate attractive returns over the next couple of years.
Besides AAPL and MSFT, Legg Mason also had $147 million invested in tech company EMC Corp (EMC). A few other large positions in its portfolio include eBay Inc (EBAY), BlackRock Inc (BLK) and Philip Morris International (PM). Legg Mason invested $140 million-plus in all these positions at the end of last year. All these stocks seem to be trading at low multiples. We especially like BLK and PM. Blackrock's forward P/E ratio is 13.05 and it is expected to grow at an average of 16.28% annually in the next five years. This indicates that its 2014 P/E ratio is only 9.7. BLK also has a decent dividend yield of 2.85%. Philip Morris is the best performing tobacco stock over the past two years. We bought Philip Morris for our portfolio in May 2010 during the first Greek crisis. We paid $44 per share and were receiving a dividend yield of 5.3%. The stock almost doubled since then and increased its dividends by 33%. Currently it has a dividend yield of 3.76%. We still think PM is a better investment than other tobacco stocks.
Hedge funds noticed the great opportunity in tech stocks. A large number of hedge funds invested their money in AAPL, MSFT, GOOG and ORCL. For example, there were 95 hedge funds with MSFT positions and 127 hedge funds with Apple positions at the end of the fourth quarter. Boykin Curry is the most bullish hedge fund manager about MSFT. His Eagle Capital Management had nearly $500 million invested in MSFT. Ken Fisher, Jean-Marie Eveillard and David Einhorn were also bullish about MSFT. All of these fund managers had over $350 million invested in this stock.
We believe an investor betting on both Apple and Microsoft will reduce the risk associated with market share gains/losses between these stocks. Since both stocks are trading at very low valuations, investors' average return over the long-term will probably beat the market.