Sound Shore Fund 2Q16 LetterVW Staff
Sound Shore Fund letter for the second quarter ended June 30, 2016.
The Sound Shore Fund Investor Class (ticker SSHFX) ended June 30, 2016 with a net asset value of $41.99 per share, after an income distribution of $0.249756 on June 16th. The second quarter total return was 1.69% versus the Standard & Poor’s 500 Index (“S&P 500”) and Dow Jones Industrial Average (“Dow Jones”), which returned 2.46% and 2.07%, respectively. Year to date, the Fund has gained 2.28% versus 3.84% for the S&P 500 and 4.31% for the Dow Jones.
We are required by the SEC to say that: Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. The Fund’s Investor Class 1, 5, 10, and 15-year average annual total returns for the period ended June 30, 2016 were -3.41%, 10.67%, 6.36%, and 6.42%, respectively. As stated in the current prospectus, the Fund’s Investor Class total annual operating expense ratio (gross) is 0.93%. For the most recent month-end performance, please visit the Fund’s website at www.soundshorefund.com.
Sound Shore Fund
Equity markets finished higher in the second quarter of 2016, though the UK “Brexit” vote prompted a decline in late June. The referendum’s outcome, which caught many investors off guard, rekindled global growth concerns and drove interest rates on sovereign bonds to multi-year lows, including those with yields already below zero (NIRPs1). Against that backdrop, the defensive “bond proxy” stocks in telecommunications and utilities continued to be among the markets’ best performers despite their above normal valuations. In fact, the S&P Utility Index’s 19 times price-earnings (“P/E”) multiple is its highest in over 15 years, and also reflects the sector’s current fad-like status. Now in our 38th year, Sound Shore Management has invested through all varieties of markets. Though our performance lagged this quarter, our experience has been that adhering to our disciplined value strategy, including resisting fads, remains the best route to competitive long-term returns for our investors.
As a reminder, Sound Shore’s investment process starts with an opportunity set of the what we deem to be the least expensive stocks based upon price-earnings multiples. From there, we conduct bottom up research to identify companies where internally driven earnings and cash flow improvement will drive investment results. Within that framework, Capital One and Invesco declined in June’s selloff despite reporting solid fundamentals during the period: For example, asset manager Invesco disclosed better than expected mutual fund flows while card issuer Capital One posted loan growth above consensus. In addition, both companies boast 2016 shareholder yields (dividends plus share retirements) of over 8%. Given these companies’ financial progress, strong balance sheets, and attractive valuations at ten times earnings or less, we used the volatility to add to our positions.
Contributing to performance was semiconductor equipment provider Applied Materials as it bucked the underperformance trend in the technology sector. We invested in the company several years ago when the stock was priced below normal at 12 times forward earnings. Our investment thesis included management building value through market share gains and operating discipline. Over this period, Applied’s earnings per share has outpaced its peers thanks to differentiated 3D NAND and 10 nanometer technologies for its semiconductor foundry customers, and the stock has outperformed. Even so, the stock’s current valuation remains very reasonable at 13 times forward earnings with an 8% free cash yield, with market leading display technologies now driving additional growth.
As well, drug maker Pfizer was a strong second quarter performer as its new product pipeline, including innovative cancer treatments, garnered valuation credit. We started our investment during the first quarter of 2016 when pharmaceutical stocks sold off broadly due to woes at a specialty competitor. In addition, Pfizer was held back by concerns about a since scuttled acquisition attempt, providing us with the opportunity to invest at 13 times P/E and a 7% shareholder yield (dividend plus share repurchase). After almost a decade of flat earnings, Pfizer’s differentiated lineup and strong expense control should yield sustainably higher earnings per share, as was evident in results released during the June quarter.
We expect much of the coming market dialogue to center on the approaching US elections, party platforms, and the effects of “Brexit.” While not ignoring these issues, Sound Shore will spend the bulk of its time sorting through the market’s bargain bin looking for company-specific opportunities where managements are building value regardless of the environment. We note that at June 30, 2016, Sound Shore’s portfolio had a forward price-earnings multiple of 14 times consensus, a meaningful discount to the S&P 500 Index at 17 times, despite our holdings’ strong balance sheets and free cash flow.
Thank you for your investment alongside ours in Sound Shore.
SOUND SHORE FUND
Harry Burn, III
John P. DeGulis
T. Gibbs Kane, Jr.
See the full PDF below.