Stay the course Since 1998, Central Banks in both the US and Europe have had a huge affect on the movements of the stock market and I would argue that this intervention has been largely necessary and successful. However, one of the side effects has been the introduction of volatility into the stock market as various market participants try to guess either a given Central Bank’s next move or the markets’. After a strong start to the year the market once again seems to be going through a liquidity based correction that flies in the face of the picture we see with respect to both corporate earnings and asset prices. Gold and oil prices remain firm yet stocks in those industries have sold off aggressively. This correction could be a foreshadowing of a global slowdown but my sense is that it has more to do with market participants at the margin trying to second guess the US Fed or the European equivalent. Our recommendation is to stay the course. Equities in general are near generational lows and notwithstanding the volatility, we think now is the time to own stocks. How we look at growth We often find ourselves owning high Return on Equity (ROE) stocks that the brokerage community is less than enthusiastic about. We are comfortable with this divergence of opinion for several reasons. One can surmise what some of those reasons are but there is also a less cynical reason that I will subsequently explain. In short, we look at growth differently than most Bay Street analysts and we continue to like our approach to growth better than theirs. To illustrate our point, let’s look at two simple examples. In the first, imagine a company that earns $2.00 a share in 2011 on an equity base (BVPS) of $10.00. That equates to a 20% ROE ($2.00/$10.00). Let’s says that this company only grows by acquisition. Thus, in the absence of any acquisitions, the street analyst will assume that earnings will once again be $2.00 per share in 2012 and thus in the street analysts view, the stock/company is not growing. We look at that the exact same company much differently. In the same example, the equity (BVPS) will now grow from $10.00 to $12.00 and even though the VOLUME 19 APRIL 2012 INVESTMENT ISSUES • STRATEGIES • INSIGHTS FROM DONVILLE KENT

2 ROE REPORTER | DKAM ROE will fall to 16.7% ($2.00/$12.00), we still view that 16.7% growth rate as the true measure of growth in the enterprise, not the EPS growth rate. This view also assumes that the company does nothing useful with the $2.00 of retained earnings. Regardless, that same company that the street thinks has no growth is in our view actually growing by 17% and if priced right might be a fairly attractive investment. If we have confidence that management will use the new $2.00 in cash wisely than we can become even more enthusiastic. A second example of how our view on growth differs from the street is as follows. Let’s assume that we are told by a street analy st to take a look at a company that will enjoy 100% earnings growth this year. Upon closer review, we see that the Company’s earnings will grow from $0.20 to $0.40 this year so indeed earnings are doubling. However, the said Company also has an equity base of $10.00 per share like the first company and thus the ROE is rising from 2% to 4%. In our view the net worth of the business is growing by only 4% and thus, all things being equal we would find it much less exciting than the Company we discussed in the first example. This company may very well be a start-up and the ROE may very well rise in subsequent years but generally speaking we are not interested in owning businesses where the equity (or BVPS) is growing at a single digit rate. Thus, the two examples describe 1) a company with flat earnings and 2) a company with earnings that will double over the current year. However, we strongly believe that earnings growth is a poor measure of the value creation process that drives the long-term performance of stocks. ROE should of course never be seen in isolation from valuation but the two cases do highlight where the streets valuation methodology and ours are at odds. We are comfortable being different. Companies like Constellation Software, Paladin Labs, Stantec, MTY Food Group, CGI Group and others look a lot like the Company described in our first example. All have consistently high ROE’s although a few are not cheap enough for us to own at this time. They also often have undefined growth plans because th ey don’t and can’t tell the analyst community what they will acquire until they do so. As such, the stocks tend to go quiet from time to time while we await the next acquisition or growth initiative and during times like this many analysts claim that these companies are not growing. This is of course until they announce a major acquisition or something similar. Then of course it’s too late. The stock pops 15 -20% and if you are out of the stock you wonder why.

3 ROE REPORTER | DKAM The key to understanding these companies and owning them is getting comfortable with the idea that companies with high ROE’s generally have two very positive things going for them. First, the high ROE is probably based on some kind of competitive advantage that is persistent. Second, if management is adept at managing the retained earnings then new investments are made that allows the ROE to stay high or the company wisely returns the retained earnings to shareholders in the form of dividends or share buy-backs. Thus, if a Company has enjoyed an ROE for the past five years that has consistently hovered at around, say the 25% level, without even knowing what the Company does it is fairly likely that 1) the Company has some type of competitive advantage and 2) the Company is relatively astute at managing and deploying its retained earnings. This in essence describes the companies we like to own the best. Constellation Software enjoys a high ROE on its existing business and has a terrific track record of buying new companies with the cash, or paying out the rest in dividends. Paladin Labs does not pay a dividend or buy back its stock. However, they are very astute and consistent acquirers and they have $250MM to spend. Home Capital is not an acquirer. They keep their ROE consistently

4 ROE REPORTER | DKAM high by recycling profits into a steadily increasing base of mortgages. CGI Group, like Paladin does not pay a dividend but the company consistently buys back its stock and from time to time makes a great acquisition. None of these stocks moves in a straight line but their ROE’s are wonderfully consistent from year to year. Identifying companies like these, which possess consistently high ROE’s, is the best way to expand ones wealth in the equity markets. Concluding thoughts We have had a good start to the year, up close to 4.89% in the first quarter of 2012, but markets have been correcting in April. We remain confident that the full year results for the TSX will be better than 2011 and positive. Valuation is not a timing device but that said, we view equities to be extremely undervalued. Call if you want to chat – JP Donville – 416-364-8886.