December 31, 2023
The Sound Shore Fund Investor Class (SSHFX) and Institutional Class (SSHVX) advanced 12.43% and 12.50%, respectively, in the fourth quarter of 2023, ahead of the Russell 1000 Value Index (Russell Value) which advanced 9.50%. As of December 31, 2023, the three year annualized advances for SSHFX of 9.12% and for SSHVX of 9.34% were also ahead of the Russell Value’s 8.86%. As long-term investors, we highlight that Sound Shore’s 35 year annualized returns of 10.14% and 10.43%, for SSHFX and SSHVX, respectively, as of December 31, 2023, were ahead of the Russell Value at 9.94%. For the Fund's most recent standardized performance information, click here.
It was an excellent year for Sound Shore’s portfolio, gaining 17.42% for SSHFX and 17.67% for SSHVX in 2023, both well ahead of the Russell Value’s return of 11.46%. We began the year with a lot of hand wringing on Wall Street as geopolitical tensions flared and the macro outlook was as uncertain as ever. The Federal Reserve took investors on a roller coaster ride of recession fears that ebbed and flowed. Throughout the year, inflationary pressure on the economy and markets remained front and center and some of us brought this cartoon home at the holidays. Adults around the table all seemed to enjoy a good laugh out of it. The children…not so much.
Despite the market narrative often dominated by fascination with the “Magnificent Seven” mega-cap growth stocks that led the Standard & Poor’s 500 Index returns, under the hood there was plenty of opportunity. Given higher interest rates and the adjustment to COVID’s boom and bust impact on various industries, there was quite a lot of dispersion in the equity market. And so, forty years after the release of The Police’s final studio album, Synchronicity, we find ourselves in a period of a-synchronicity. In other words, what we like to refer to as “mini-cycles” within and between industries and geographies, at different points in time. As correlations came down and with a number of stocks trading for very attractive valuation levels, the opportunity set for our fundamental value strategy improved, as evidenced by our strong return in the fourth quarter.
Apparel maker PVH led all contributors for the quarter and was one of our best performers for 2023. As we discussed in our letter at the end of last year, the stock sold off in the second quarter of 2022 as it fell on consumer spending concerns and despite the company’s core business continuing to grow. We believed that with leading brands such as Tommy Hilfiger and Calvin Klein, along with a strong balance sheet to withstand a sales slowdown, PVH was executing well in a challenging environment. We added to our position at the time and our conviction has been rewarded. This year, margins have improved as the company focused on improving the quality and cost structure of their best selling products. This has allowed earnings to grow against a challenging retail backdrop. PVH’s management team has targeted even higher margin improvement which would lead to earnings power (EPS) of more than $18 per share, compared to the current EPS of $11.
Long-term holding Capital One was also one of our better performers this quarter. The company boasts a diversified deposits base with about 80% FDIC insured, well above industry average. It is the only major bank 100% in the cloud, which enables better underwriting and quicker response to changes in the environment. This technology also helps reduce operating and fraud cost while freeing up cash flow for reinvestment in marketing to grow products (Venture X card) and build its brand. Periods of stress, like we saw in the banking sector during March, are a reminder of the underwriting acumen and high quality deposits of Capital One. We added to our position after the fallout, knowing that the company’s seasoned management team had steered capably through previous cycles. Today, as credit card delinquencies have risen to more normal levels, Capital One is already reporting a slowing in delinquency growth. Conversely, some peers saw prior underwriting missteps begin to surface in 2023. Currently trading at 9 times 2024 consensus earnings and around book value, we remain enthusiastic about the investment.
Value investing often requires patience, and the passing of legendary value investor and Berkshire Hathaway’s Vice Chairman, Charlie Munger, reminded us of one of his more insightful quotes…“It's waiting that helps you as an investor and a lot of people just can't stand to wait.” Healthcare holding Organon provides a similar scenario today. The stock lagged in the fourth quarter and for 2023 due to concerns about long-term revenue drivers. Non-operational factors (currency, interest rates and separation charges) have masked growth that has exceeded expectations. A spinoff from Merck, Organon has a very steady pharmaceutical business and is investing to grow its women’s health franchise. Trading for just 4 times earnings, the company is growing steadily, investing in its research & development pipeline and generating ample cash flow to repay its debt. Despite near-term weakness, we think Organon is an attractive opportunity for patient, long-term investors like Sound Shore.
For the year, we had a number of stocks up 50% or more and the list includes a diverse set of industries such as homebuilding, heavy truck manufacturing, and semiconductor capital equipment. We would like to highlight one outstanding contributor for the year, electricity generator and marketer Vistra Corp., a low-cost provider with a healthy balance between generation and retail. Demand for electricity is growing and notably, load peaks are changing as well. As the country brings on more renewables and adjusts to greater demand later in the day due to increased use of electric heat pumps and electric car charging, reliable clean power is at a premium. Vistra is well positioned with diversified fuel sources including solar, natural gas, coal, nuclear and battery power storage facilities, along with a marketing division to manage price volatility. The company will soon be closing its accretive acquisition of merchant power generator, Energy Harbor, and the deal will make Vistra the second largest carbon free, nuclear electricity provider behind Constellation Energy, another portfolio holding. Vistra CEO Jim Burke, leads a veteran utility management team that is committed to transitioning the company’s portfolio to a sustainable footprint by closing older fossil fuel plants and increasing the renewables portfolio. They have also been an important voice to advocate for changes that will accelerate the global transition to a clean, renewable energy future, while maintaining adequate near-term supply. Vistra has a strong balance sheet that allows the company to invest in innovation and operational improvements. Additionally, management is using excess cash flow to buy 40% of the outstanding shares over a five year period and they are more than half way through that process. Currently valued at 9 times earnings with a 17% free cash flow yield and a 2.3% dividend, the stock remains a full position. As you can see from the chart below, Vistra’s performance was quite different than many other electricity providers and provides further evidence of the disparate performance that can often be found within a sector.
VISTRA CORP. vs UTILITIES INDEX vs RUSSELL 1000 VALUE INDEX
Detractors for the year included some of our healthcare holdings, which underperformed along with the sector as the excitement for weight loss drugs seemed to siphon a lot of capital away from other parts of the healthcare industry. One example is healthcare solutions provider Centene; another position we initiated earlier this year when it was trading at a below normal 9 times earnings. While the stock is up from purchase, it has underperformed the overall market. Thus far, the company’s Medicaid business is performing as expected. Meanwhile, a new management team, led by Sarah London, formerly of United Healthcare, is in its second year of turning around the business. We have been impressed with the initial success the company has shown streamlining its business and improving operating performance and the stock remains a full position.
Over forty five years and numerous market cycles and periods of uncertainty, we’ve learned that conviction, judgement and stock picking are what deliver results. This year again provided confirmation that our strategy doesn’t need a value-driven market to produce attractive returns. Sound Shore’s portfolio holdings responded well to company-specific drivers of performance, signaling a more balanced market with lower correlations. Meanwhile, we are continuously researching stocks that are cheap versus their historic norms and the market, where value is building ahead of expectations. In the current environment, our emphasis on stock-specific sources of outperformance should prove as relevant as ever, despite a long list of concerns about the economy and market volatility.
We note that as of December 31, 2023, Sound Shore’s portfolio had a forward price-earnings multiple of 11.1 times consensus estimates, a meaningful discount to the S&P 500 Index at 19.5 times and the Russell 1000 Value Index at 14.7 times. It is our belief that the Sound Shore portfolio has tremendous value.
We’ve recently participated in interviews on popular, investment-focused digital platforms, including a podcast discussing Vistra Corp., participation in a Value Equities panel, and a brief interview about what we see in today’s market. Please click here for the interviews.
Thank you for your investment alongside ours in Sound Shore.
An investment in the Fund is subject to risk, including the possible loss of principal amount invested. Mid Cap Risk: Securities of medium sized companies may be more volatile and more difficult to liquidate during market downturns than securities of large, more widely traded companies. Foreign Securities Risk: The Fund may invest in foreign securities primarily in the form of American Depositary Receipts. Investing in the securities of foreign issuers also involves certain special risks, which are not typically associated with investing in U.S. dollar-denominated securities or quoted securities of U.S. issuers including increased risks of adverse issuer, political, regulatory, market or economic developments, changes in currency rates and in exchange control regulations. The Fund is also subject to other risks, including, but not limited to, risks associated with value investing.
The Adviser analyzes risk on a company-by-company basis. The Adviser considers governance as well as environmental and social factors (ESG) as appropriate. While valuation, governance, environmental and social factors are analyzed, the evaluation of all key investment considerations is industry- and company-specific. Consequently, no one issue necessarily disqualifies a company from investment and no individual characteristic must be present prior to investment.
Diversification does not assure a profit or protect against a loss in a declining market. The Dow Jones U.S. Utility Index, a member of the Dow Jones Global Indices® family, is designed to measure the stock performance of U.S. companies in the utilities industry.
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 their original cost.
The views in this letter were those of the Fund managers as of 12/31/23 and may not necessarily reflect their views on the date this letter is first published or anytime thereafter.
This commentary may contain discussions about certain investments both held and not held in the portfolio. Current and future portfolio holdings are subject to risk. For the Fund’s Top 10 Holdings click here.
You should consider the Fund’s investment objective, risks, charges and expenses carefully before investing. The summary prospectus and/or the prospectus contain this and other information about the Fund and are available from your financial intermediary or www.soundshorefund.com. The summary prospectus and/or prospectus should be read carefully before investing.
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