Sound Shore Fund letter to investors the period ended December 31, 2014.
The Sound Shore Fund’s Investor Class (ticker SSHFX) ended December 31, 2014 with a net asset value of $48.79 per share, after a year-end capital gains distribution of $5.055042 per share. The fourth quarter total return of 2.96% lagged the Standard & Poor’s 500 Index (“S&P 500”) which rose 4.93% and the Dow Jones Industrial Average (“Dow Jones”) which rose 5.20%. For the year, the Fund’s Investor Class gained 11.76% which trailed the S&P 500 and outperformed the Dow Jones, which had returns of 13.69% and 10.04%, respectively.
Sound Shore Fund: Performance
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 December 31, 2014 were 11.76%, 14.70%, 7.53%, and 7.99%, 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.
Stock markets gained in 2014 as investors took encouragement from solid corporate profits, and otherwise looked through concerns that ranged from geopolitical unrest to the end of Quantitative Easing in the US. Uneven domestic growth and generally slower international economies led to more divergent than usual central bank policies and volatile currency markets. Against a backdrop of lower than expected interest rates, the “bond proxy” utility stocks were the S&P 500’s best performers. By contrast, energy was the market’s only declining sector as oil prices nearly halved from September to year end.
Sound Shore Fund: Contributors to performance
Sound Shore’s company-specific focus on undervalued earnings and free cash flow resulted in a diverse lineup of 2014 contributors: Our seven best stocks spanned six different sectors. Among these was aluminum maker Alcoa, the year’s best performer, which outdistanced its lagging materials peers and also provided a great Sound Shore case study. We invested in Alcoa during the second half of 2013 when the stock was attractively priced at five times cash flow, ten times normalized earnings, and below book value. Alcoa was so out of favor that, in September 2013, Dow Jones removed the stock from its iconic Industrial Average after 55 years of inclusion. Our research concluded, however, that Alcoa’s plans to grow its highly profitable engineered products unit and also cut smelting and refining costs would build significant value. Since our investment, consensus earnings forecasts for Alcoa have doubled as management has executed internally and also as aluminum fundamentals have tightened. After a gain of 67%, well ahead of the market, Alcoa achieved our target valuation and we sold our position in December 2014.
Pharmaceutical supplier Hospira also performed well in 2014, advancing 48%. We started our position in this injectable generic drug leader in early 2013 when the stock was priced well below historic norm on sales due to a manufacturing startup delay. We viewed the facility issue as temporary, and also believed that management’s plan to improve returns through both improved manufacturing consistency and new biosimilar products would yield above consensus earnings power. In the interim, Hospira shares have advanced as the company executed on its plan and also benefitted from industry capacity constraints.
Sound Shore Fund: Detractor to performance
A few holdings with greater international exposure lagged, especially in the fourth quarter. Global glass packaging leader Owens-Illinois was the biggest 2014 detractor due to demand concerns in Europe, its largest market. Valued at under ten times earnings and with a 9% free cash flow yield, we believe O-I retains an attractive risk-reward profile. As well, integrated oil BP, which we purchased well after the 2010 Gulf of Mexico oil spill, declined due to lower oil prices. BP’s merits include a strong balance sheet, a competitive cost structure, and proactive management. Viewing energy overall, Sound Shore managed to eke out a modest gain from the sector in 2014 and had limited direct exposure at year-end.
The chart below from the Fund’s website (www.soundshorefund.com) illustrates the historical, longterm rewards of patience combined with our investment process: A hypothetical $10,000 purchase of the Sound Shore Fund at its May 17, 1985 inception would be worth $249,398 (assuming dividend reinvestment) as of December 31, 2014. This 25-fold gain occurred during a 29-year timeframe which saw three bear markets (S&P 500 declines of 25% or more) and nine corrections (declines greater than 10%). Sound Shore’s results have been due to our absolute performance amplified by the power of compound interest, which Albert Einstein is reported to have described as the “eighth wonder of the world.”
As the Sound Shore Fund approaches its 30th year, we very much appreciate your confidence in us. With the outlook, as always, unclear, we will continue to invest in out-of-favor stocks of companies with solid managements, sound balance sheets, and good business prospects.
Thank you for your investment alongside ours in Sound Shore.
SOUND SHORE FUND
Harry Burn, III
John P. DeGulis
T. Gibbs Kane, Jr.
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