Miller at Legg Mason's Baltimore headquarters
Photo: Melissa Golden
By Jon Birger
October 10, 2013

He’s back. Whether Legg Mason’s Bill Miller is better than ever remains to be seen. But lately this onetime mutual fund megastar seems to have regained his knack for picking stocks. Miller’s current fund — Legg Mason Opportunity Trust, which he co-manages with Samantha McLemore — has the highest trailing 12-month total returns of any domestic equity fund. Categorized by fund tracker Morningstar as midcap value but really more of a go-anywhere fund, Opportunity Trust’s 65% one-year return beat the Standard & Poor’s 500 index by a whopping 46 percentage points. Barring a late-year meltdown, 2013 will mark the fourth year of the past five in which Opportunity Trust has outperformed the S&P 500. That’s a far cry from Miller’s 1991-through-2005 heyday, when his Legg Mason Value Trust beat the S&P for 15 consecutive years. The streak ended badly, though, as Miller stuck too long with homebuilders and other disasters like Eastman Kodak and Fannie Mae. The low point came in 2008 when Value Trust lost 55% and investors fled. Miller relinquished Value Trust’s reins in 2011 but retained control of Opportunity Trust. Fortune sat down with him to discuss his recent success and what he learned from past missteps. Edited excerpts:

Given the number of cyclicals in your portfolio — Delta Air Lines, Bank of America, homebuilders like Pulte and KB — you seem optimistic.

I wouldn’t say it’s a particularly bullish portfolio to the extent that I’ve got an out-of-consensus view that requires some sort of change in the environment to succeed. I’d call it an obvious portfolio. What’s happened is that risk aversion among investors is so high that everybody is now focused on risk management. They tend to think more about reducing volatility than about making money.

Give me an example.

It’s obvious that housing is getting better. We’ve gone through the worst housing collapse in history. Affordability [of housing] is now at the highest it’s ever been. Housing starts are at the lowest they’ve ever been, and home prices are still below replacement value. We’re one year into a housing recovery, yet suddenly the Wall Street Journal is writing that it’s all over — that the stocks went up a lot last year, so that’s it. I disagree.

Do you have a favorite stock today?

Apple. The argument you hear most is that Apple trades on earnings-estimate revisions. And with the new iPhone launch, Apple just announced it’s at the top end of its earnings guidance for the fourth quarter. On top of that, we’ve got a new iPad coming next month, and [a deal with] China Mobile probably coming in the next three to six months. We’ve got the iWatch coming too. So the path for earnings estimates points higher.

Is that your main argument for Apple?

No, that just informs our timing. My argument is that it’s worth at least 50% more than where it’s trading. People say Apple isn’t innovating enough. Well, how much innovation does Nike do? Apple is a consumer brand, a design company with a huge and loyal following. In Japan there was a typhoon bearing down, and people were still sitting outside an Apple Store waiting to get the new iPhone. If you value Apple like people value Nike [which has a P/E ratio of 24, vs. 12 for Apple], it’s probably worth double what it is now. But we’re being conservative and saying 50%.

When you look back at 2007 and 2008, presumably there are stocks, like Kodak, that you’d like a do-over on.

Kodak was one of the worst investments we ever made, in part because we owned it for so long. The lesson there is an easy one: Even if you believe in a turnaround, when a company has got negative cash flow and they keep missing on all the metrics, you use an old Ben Graham rule and sell it after 24 or 36 months. You can always return again if it looks better.

Are you investing differently today?

We won’t own illiquid securities because they were so hard to sell when redemptions hit Value Trust. Back in 2008, the illiquids cost us [20 percentage points]. Also, the old Bill Miller would have been very interested in the catastrophes going on in Europe over the past few years and might have been tempted to go into European financials. Because of the 2008 experience, I won’t do that.

The airline industry always seems to find a way to disappoint, yet you’ve got Delta, United Continental, and US Airways among your top-20 holdings.

Warren Buffett said that if there’d been a true capitalist at Kitty Hawk, he would have shot the plane down and saved the world a lot of money. Until a few years ago, the largest market share of any domestic airline was 12%. If you take a low market share in a commodity business with high debt, lots of regulation, and unpredictability as to input costs, it’s a recipe for price wars and bankruptcy. But when you saw consolidation — first with Delta-Northwest and then United-Continental — you went from a fragmented industry to one in which two carriers control 50% of the business. Suddenly the pricing discipline got a lot better, and the capacity discipline got a lot better. And if the American-US Airways merger goes through, the top four will control 90%.

This story is from the October 28, 2013 issue of Fortune.

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