December 31, 2024

The Sound Shore Fund Investor Class (SSHFX) and Institutional Class (SSHVX) advanced 1.25% and 1.32%, respectively, in the fourth quarter of 2024, trailing the Standard & Poor’s 500 Index (S&P 500) which advanced 2.41% and ahead of the Russell 1000 Value Index (Russell Value) which declined 1.98%.  It was a strong year for Sound Shore’s portfolio, with SSHFX gaining 22.58% and SSHVX rising 22.82% in 2024, substantially ahead of the Russell Value’s return of 14.37%.  As of December 31, 2024, the three year annualized advances for SSHFX of 8.78% and for SSHVX of 9.00% were in line with the S&P 500’s 8.94% and were ahead of the Russell Value’s 5.63%.  For the Fund's most recent standardized performance information, click here.

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.

Within the widely followed S&P 500, the year featured familiar winners, which got even bigger as the “Magnificent 7” now represents 33% of the cap-weighted S&P 500 and accounted for over 50% of that Index’s return.  2024 also had its fair share of macro factor angst with the Federal Reserve and US elections prominently in the headlines, and we are often asked to put those in perspective.  However for this letter, we decided to take a different approach.  Although we will touch on a few stocks that helped drive performance this year, we wanted to shed some light on our process and the opportunities that we believe exist for a disciplined value strategy.  (For those of you that love to talk stocks, like us, drop us a note.  We’d be happy to set up a call to drill down on the names that interest you the most.)

"The four most dangerous words in investing are 'this time it's different.'," once warned legendary investor, Sir John Templeton.  While markets generally follow consistent patterns, there are moments of significant change that create unique investment opportunities.  Yes, we acknowledge that economic cycles exist and often rhyme, but every cycle has its peculiar elements.  This most recent cycle included a once in a 100-year Pandemic and fiscal and monetary stimulus that was unprecedented outside of a world war.  These are now in the rear view mirror.  Regardless, our focus has always been inside the industries and companies that make up our investable universe.  Businesses evolve over time.  Some succeed, while others fail.  It’s our job to anticipate change in order to reap rewards that cannot be found by just owning a large passive index.  The point being, it’s important to define what “it” is when debating what may be different.  In the spirit of John Templeton, we agree that human nature does not change and that can lead to excesses in either direction.  Once again, we understand that momentum and cycles are ever present in the investment world and in the recent cycle many have plowed into leveraged private companies and the Magnificent 7.  However, we are contrarians and once the capitalization of an asset class or company has a “T” (for TRILLION) in front of it, well...that’s different!

The Opportunity:  Investing in Overlooked Transformation

The cartoon above made us think of the saying, “Everything old is new again.”  While many investors are focused on the exciting, high-growth potential of artificial intelligence (AI) and technology, we see compelling value in out-of-favor companies undergoing fundamental transformations, regardless of the drivers.  These are not antiquated companies in danger of becoming obsolete, but rather well managed and capitalized businesses that are winning in their respective industries.  High quality, overlooked businesses can often trade at discounted valuations, setting the stage for substantial returns as the market recognizes their true potential.  The impact of AI will be felt much more widely than just a handful of semiconductor and cloud service companies.  Yes, they are the first wave, but our research has identified second and third derivative impacts that will likely become more apparent as this technology evolves.  In fact, this year our contributors included a handful of companies that also benefited from the wave of investment in AI.  Our portfolio had exposure to AI in a number of industries including:

• Utilities: Vistra Corp. is a leading electric power producer with increasingly important, carbon free nuclear facilities to power data centers.  (Please see our 4Q 2023 letter for a more in-depth review of Vistra.)

• Energy: Baker Hughes is a leading innovator in the energy sector with equipment that utilizes AI to analyze production data and helps manage methane emissions.  Additionally, the company is the leading supplier of LNG infrastructure that enables natural gas to replace coal and crude oil globally to reduce carbon emissions.

• Information Technology: Oracle is a leading database and cloud service provider with proven expertise in autonomous innovation and data analysis.

Importantly, AI is only one of many other drivers in the economy and we keep a keen focus on all of the secular change found within the industries and companies in our universe.

Our Approach:  Identifying and Capitalizing on Hidden Value

We specialize in identifying companies undergoing significant, yet often overlooked, transformations.  Our rigorous research process focuses on:

• Industry Shifts:  Identifying sectors experiencing fundamental changes in dynamics, creating opportunities for innovative companies to emerge.

• Management Change:  Recognizing the impact of new leadership with a proven track record of operational excellence and strategic vision.

• Undervalued Assets:  Targeting companies with strong fundamentals and attractive valuations relative to their growth potential.

Case Studies:  Our approach in practice

• Flex (FLEX):  This contract manufacturing services company has evolved from low-value, electronics assembly to high-value, specialized manufacturing for industries like medical, industrial, and automotive.  CEO Revathi Advaithi instilled operational discipline and focused on core differentiation, leading to double-digit earnings growth and expanding margins.  We were able to invest in FLEX at less than 8 times depressed earnings as many investors were looking in the rear-view mirror.

• Teva Pharmaceutical (TEVA):  Traditionally known as a generic drug company, Teva has a growing branded drug business and a promising pipeline.  Following a period of poor capital allocation decisions by prior management teams, we were able to invest at a very attractive 4 times earnings and with a 20%+ free cash flow yield.  New leadership has focused on execution and pipeline development, leading to upward inflection in margins and positive clinical trial results.  Teva remains remarkably cheap, trading at a significant discount to its intrinsic value.  (Please see our 2Q 2024 letter for a more in-depth review of Teva.)

Our cumulative knowledge, gained from decades following industries and sub-industries gives us a unique perspective and a sense for identifying change.  While our timing is never perfect, Sound Shore’s repeatable investment process, looking well below the surface, results in pattern recognition and an elevated chance of success.  Notably, we have enough experience and humility to acknowledge we do not always get it right.  Therefore sometimes your best decisions are when you decide to sell an underperforming investment.

• Boeing (BA):  A detractor for the period was global aerospace leader Boeing.  We were able to purchase the stock at a prospective 10% free cash flow yield on a normalized scenario.  Over the past couple of years the stock rebounded from operational challenges and had surged on improved free cash generation from increasing order activity, driven by global demand for aircraft.  It was one of our best performers in the fourth quarter of 2023 after its November plane deliveries increased.  When additional manufacturing issues surfaced in January 2024, we believed it would push restructuring efforts back enough to warrant a review by our team.  Reacting quickly, we sold our position at a gain in the first quarter, albeit less than before the news.

Our partnership with you:

We appreciate your investment alongside ours at Sound Shore.  We truly view ourselves as an extension of your investment office and together we are capitalizing on these overlooked opportunities.  Our deep industry knowledge, rigorous research process, and disciplined investment approach position us to deliver solid returns.  We ask the same of ourselves as we do our investment partners; patience is required to benefit from our expertise in identifying undervalued companies with significant growth potential.  Regardless of the market environment, our strategy maintains the following pillars:

• Experienced Management Team:  Trust in our proven track record of success in navigating market cycles and generating long-term results.

• Value Creation:  Participate in the growth of companies undergoing transformative change, leading to sustainable, long-term shareholder value.  Sound Shore provides a differentiated return stream versus passive investments.

After a few years of strong equity markets, many debate whether it is actually different this time.  We are certainly encouraged that stock performance based upon company-specific fundamentals seems to be more characteristic of recent markets.  In stark contrast to the concentrated, passive indices mentioned above, this year our performance was driven by 18 stocks (from 8 different sectors) that rose 20% or more.  We note that at December 31, 2024 Sound Shore’s portfolio had a forward price-earnings multiple of 11.5 times consensus, a meaningful discount to the S&P 500 at 21.5 times and the Russell Value at 16.0 times, despite strong balance sheets and free cash flow.

To hear from our team directly, please go to our website to access short video clips, including our Meet the Team introduction:  https://soundshorefund.com/insights-news/

Thank you for your investment alongside ours in Sound Shore.