Quick Take: The managers of the Sound Shore Fund (SSHFX) keep a “considerable amount” of their own money in it, according to T. Gibbs Kane Jr., who helps oversee the portfolio.
“It’s a convenient way for us to own the stocks that our clients own,” says Kane, the president of Sound Shore Management Inc., the fund’s investment advisor. In all, Sound Shore manages about $3.5 billion in assets, mostly for institutions.
In choosing investments, the managers scan for large companies whose stocks are trading below their historical multiples because of a problem that the team thinks is transient. The $1.6-billion fund has consistently kept ahead of its peers and the Standard & Poor’s 500-stock index over the short and the long run.
This year through April, Sound Shore gained 1.3%, versus 0.4% for the average large-cap value fund, and 0.1% for the S&P 500. For the ten years ended last month, Sound Shore returned 12.8%, on average, versus 10.1% for its peer group and 11.4% for the index.
In addition to its outstanding returns, the Sound Shore fund also sports an expense ratio of 0.98%, versus 1.40% for the peer group. The portfolio is no more volatile than the average large-cap value fund and has a lower beta.
The Full Interview:
When it’s suggested to money manager T. Gibbs Kane Jr. that he invests like Goldilocks, he doesn’t disagree. After all, both shun extremes.
“We’re not looking for absolutely terrible companies and awful businesses,” says Kane, who helps run the Sound Shore Fund. “And we’re not looking for companies that are just terrific in terms of margins and returns on equity and returns on investments.”
Kane and the other members of his team look for companies with good earnings potential whose stocks have been been beaten down because of some problem he thinks is only temporary.
The managers start by screening 10,000 companies, most of which they dismiss. They hone the list down to about 1,250 businesses with market caps of $2 billion or more, hunting for those with stocks priced low compared to the company’s earnings, book value, sales or cash flow relative to the share’s history.
When assessing margins, Kane says he prefers those at the low end of their historical range because that leaves room for expansion. He also likes to see strong free cash flow, and large or dominant industry positions. In researching companies, the fund’s managers and analysts talk to management, as well as suppliers, customers and competitors. Ultimately, 40-50 stocks enter the portfolio.
In the first quarter this year, the fund took a stake in El Paso Corp (EP), a natural gas pipeline company that investors have been wary of lately because of accounting problems. Kane, however, says he is optimistic about the company because its margins and balance sheet have been improving. He reasons, too, that with natural gas prices high, investors will focus on El Paso’s ability to locate new supplies. At the same time, its pipeline continues to help the company generate cash. Those factors, combined with some new top executives, should push its shares higher, Kane says.
Another stock they managers bought in the first three months of 2004 is computer maker Hewlett-Packard (HPQ). Kane says the market has assigned the company’s printer business a value that’s too low. “It’s not exactly a hidden jewel,” he says of those operations. “But it’s under appreciated, in our view.”
The fund’s No. 1 stock at the end of March was Berkshire Hathaway`A` (BRK.A), the holding company run by well-known investor Warren Buffett.
Sound Shore has owned Berkshire’s class A shares since March 2001, and though the stock is not as inexpensive as it was then, it’s still cheap, Kane says. That’s because, he and other members of the fund’s management team, point out that in holding Berkshire, people also get to own companies it invests in, like Amer Express (AXP) and Gillette Co (G). Also, based on their method of calculating the price-to-earnings ratio of Berkshire’s stock, it trades at a discount to the Standard & Poor’s 500 index, team members have said.
Sound Shore’s second-largest holding at the end of the first quarter was media conglomerate Liberty Media `A` (L). Kane says the stock is priced relatively low. In addition, he says he admires John Malone, Liberty’s chairman, because of his skill in making acquisitions.
Liberty today posted a first quarter loss, compared to a profit a year earlier. The company also raised its outlooks for its Discovery Inc. and Jupiter Programming Co. units.
The fund had about 21% of its assets in stocks of financial services companies at the end of March. Holdings in the sector, Kane says, included two of its top performers in the first quarter: health insurer Aetna Inc (AET), whose shares rose 32.8%, and mortgage provider Countrywide Financial (CFC), which gained 26.4%.
When it comes to selling, Kane and his teammates will trim a holding or eliminate it from the portfolio if a stock becomes expensive or reaches the price target they set for it, or if a company’s financial fundamentals deteriorate.
In the first quarter, the fund unloaded Occidental Petroleum (OXY), an energy company, and Weatherford Intl (WFT), which provides equipment and services to oil and gas companies, because the stocks had appreciated, Kane says.
The fund’s turnover rate has averaged about 60% over the last four or five years, according to Kane. The turnover rate was 62% last year, a shade lower than the fund’s peer group. The managers plan to hold companies for two years “because it takes time to implement changes to fix their problems,” Kane says.