The Feel Good Effect Since 2007, the investment world has been in the grip of the pessimists. This happens from time to time. It also explains in part why we have stock market cycles. As a consequence of such bearishness, growth assets (common stocks) have become cheap. Over the past six months however, there appears to have been a bit of a change in the market’s mindset. The biggest influence on this change in market psychology appears to be the bottoming of and the probable turnaround in the US residential real estate market. Regardless, investors’ appetite for stocks appears to be increasing for the first time in what feels like a long time. Movements out of bond and money market funds into equities have been significant of late. The feel good effect is back in the market. For investors in the Capital Ideas fund, 2012 was another decent year, with the fund up 9.2% versus the TSX Composite’s return of 4.0%. In 2013, we expect another solid year although as always, our focus will be on finding more superb businesses to own. We will let the appreciation of the fund take care of itself. That said, the Capital Ideas Fund, which is now RRSP and TFSA eligible, has had a good start to the year and my sense is that 2013 will be another positive one for our investors. Things we can learn from history Those of you who have read even a small number of the books written about Warren Buffett will know that his investing style has changed subtlety over the years. In the early years, Buffett’s investment style would best be described as “deep value”, which means that he focused primarily on the value of an enterprise in relation to its accounting assets (book value, cash, cash earnings and net working capital). Subsequently, Buffett evolved into what many today would call a growth inves tor and what I would call a “franchise” investor. The evolution of Buffet’s investment style is worth reflecting on because it was shaped in part by changes in the investment industry over the past 70 years and also heavily influenced by the ideas of a small group of theorists and practitioners. It’s an interesting story and one that I will try to relate to the do - it-yourself investor. VOLUME XXI JANUARY 2013 INVESTMENT ISSUES • STRATEGIES • INSIGHTS FROM DONVILLE KENT

2 ROE REPORTER | DKAM Many investors today may be unaware of the state of the investment business prior to the crash of 1929. At that time, a stock’s valuation was driven mainly by promoters and manipulators and a stock’s movement tended to have little to do with its fundamentals. At the same time, annual reports, press releases and financial disclosures were infrequent and at times minimal in their detail. Indeed, the lack of financial integrity in stock markets throughout the world was seen as a contributing factor to the crash of 1929. Following the crash, a school of investing, now called “value investing”, began to emerge, led by an enterprising Wall Street analyst, investor, teacher and writer named Benjamin Graham. Graham, who had worked on Wall Street since 1914 and taught at Columbia University since 1928, surmised that a company’s value was ultimately linked to its accounting fundament als. At the same time he also began to realise that a large number of healthy companies with strong balance sheets were trading at deep discounts to their “intrinsic value.” Some of these companies were simply unknown because of the inefficient process of information dissemination at that time. Such stocks were rarely in the news but represented tremendous investment potential if their potential could be unlocked. Other companies that were better known also suffered from low valuations simply as a result of the culture of pessimism that pervaded Wall Street at that time. Graham began to figure out how to find such stocks and thus became an authority on “discovering” undervalued stocks by diligently searching through obscure publications and databases. Graham was also a teacher and his ideas about fundamental analysis were powerfully articulated in his first book, Security Analysis , which was written with David Dodd and published in 1934. At the same time that Graham was figuring out that a stock’s value was related to its accounting fundamentals, an academic by the name of John Burr Williams was formalising the mathematics that supported what Graham was essentially discovering in the field. Williams began work on his PhD in economics at Harvard in 1932 inspired partly by his curiosity with the stock market crash of 1929 and the subsequent economic depression. In 1938 Williams completed his thesis, published as The Theory of Investment Value , in which he showed that the value of an asset such as a stock was equal to the net present value of its future cash flows. Williams was among the first theorists to use the term “intrinsic value” and establish the link between cash flows and valuation. Meanwhile, Graham continued to work diligently and profitably in the field and by the late 1930’s had more than recovered from the losses he incurred during the great crash. However, it should be noted once again that Graham wasn’t buying stocks at a typical time in the stock markets history. The 1930’s were a time when companies were selling at unprecedented discounts to their asset value and thus Graham was typically buying cheap stocks of relatively strong companies that were off-the-beaten-path, under-researched or that possessed valuations that were still being affected by the lingering fear from the 1929-33 market crash. With the advent of World War II, stock markets

3 ROE REPORTER | DKAM continued to perform well and Graham continued to invest, teach, and write with his more user friendly book the Intelligent Investor first published in 1948. Warren Buffett’s career has been inextricably linked to Graham since the fall of 1950, when he arrived from Omaha, Nebraska to attend Columbia University. Buffett enrolled in Graham’s security analysis class and excelled, becoming the only student to ever earn an A+ from Graham. In 1954, Buffett joined Graham’s investment firm and so began his crash -course in Benjamin Graham style value investing. Once again, the focus under Graham was to look at companies that were trading at cheap multiples of earnings, cash flow, book value per share, and net working capital. Indeed, Graham was relatively uninterested in looking at a business’s products or strategy. As long as the company met his detailed quantitative requirements that were primarily driven from the three major financial statements, then the stock was a buy. This general approach continued to work reasonably well into the 1950’s for several reasons, including the fact that Graham and his followers were still only managing a small amount of money; value investing was still in its infancy and information about stocks remained inefficiently disseminated. In 1956, Warren Buffett left New York and moved back to Omaha and began managing money via limited partnerships. Over the next decade, two important things happened to Buffett. First, he read Common Stocks and Uncommon Profits by Philip Fisher which was first published in 1958. Second, he met Charlie Munger sometime in 1962. Both of these two men would have a significant impact on Warren Buffett’s evo lving investment style. It is hard to say exactly when or why Buffett’s investment style changed. When he first arrived in Omaha, Buffett carried on with an investing style that was similar to what he had learned under Graham. In the Midwest, Buffett was able to find many undervalued businesses that traded at deep discounts to their various accounting metrics. However, when we look back at the kinds of stocks Buffett was buying in the late 1950s, we can see that a careful analysis of the company’s business economics was probably n ot what was driving his investment decisions. Buffett called many of the stocks he was buying then “cigar butts”, the term he used for some of his obscure, deep -value investments. As Buffett moved into the 1960’s however, he became increasingly interested in companies with superior products or services that did not trade on anything close to “value” metrics. These companies offered the potential for above average growth for a sustained period of time. These were the kinds of companies that Philip Fisher had written extensively about in Common Stocks. Fisher’s ideal company had an enduring competitive advantage and his work in particular anticipated the ideas of Michael Porter. At the same time, Munger was already an astute practitioner of the ideas that Fisher was writing about and he and Buffett entered into a friendship that saw Munger gently steer Buffett away from the “deep value” camp into an investment style that focused on a company’s “franchise.”

4 ROE REPORTER | DKAM Simultaneously, the investment world slowly became a more efficient place. Databases became better, regulators forced higher standards of disclosure on public companies and investors became better educated and trained. The result was that as the 1960s and 1970s evolved, the face of value investing began to change dramatically. Finding well run companies at low valuations became difficult, and, increasingly, a stock that traded at a low multiple of book value, EPS or cash flow had some kind of problem, risk or flaw. Late in his life, Graham admitted that the type of “value” investing that he undertook in the 1930s and 1940’s was becoming increasingly difficult, if not impossible, to do. But value investing did not die. Indeed, Buffett himself has always shunned the titles of value and growth, despite the fact that the rest of the investment world finds these titles valuable for explanatory and classification purposes. Nonetheless, sometime in the 1960’s and 1970’s Buffett began veering almost completely away from what we would now call the deep value camp and began to focus extensively on businesses with strong franchises. Implications for the do-it-yourself investor If you want to invest like Buffett, you can choose to invest like the Buffett of old (i.e. the Benjamin Graham style) or the Buffett of late (i.e. the Fisher/Munger style). Both styles have their adherents and both styles, when consistently applied, still work very well. But choosing the right style for you requires careful consideration. Buffett’s old style involves buying stocks that trade a t low price to book value multiples and hopefully low price to earnings and price to cash flow multiples. However, given the market’s latent efficiency, you will generally be buying shares in companies that have “issues.” The prescient value investor mus t therefore be able to assess whether or not these “issues” are solvable and whether the market has in fact over-reacted to what will hopefully turn out to be a short-term problem. Investors who are strong at this type of investing must be astute at understanding how businesses are turned around. Related skills would be strong accounting skills, a good knowledge of corporate governance, advocacy, and bankruptcy laws. Deep value investors look to buy stocks worth a dollar for 50 cents, but they must be adept at avoiding value traps and rip-offs. This type of skill set is rare amongst professional fund managers and I am assuming even rarer amongst do-it-yourself investors. Buffett’s “new” value style involves buying stocks that represent great value not in relation to their current book value per share (or other accounting metric) but in relation to their future cash flows. Such firms typically have high returns on equity (ROE) which are normally driven by above average margins. Such businesses by implication have some kind of moat built around them which allows the enterprise to sell its products or services for much more than those products or services cost to manufacture. An investor in these types of companies must therefore be an expert at ascertaining the sustainability of these above average ROE’s and margins. Investors in these so called franchise

5 ROE REPORTER | DKAM companies expect or at least hope that these businesses will remain outstanding for a long period of time. For the do-it-yourself investor, this type of investing is much easier to do, because one simply has to monitor the ongoing performance of a great business, rather than trying to predict the turnaround of a weak one. Towards an investment strategy built around great companies The Capital Ideas fund is built around Buffett’s new value style which we also believe is an excellent style for do-it-yourself investors. This style of investing involves a few basic steps and a bit of judgement. The first step is to identify a list of po tentially great companies as evidenced by their ROE’s. In Canada, our database provides us with the following list of high ROE companies based on DKAM’s 2013 projection of cash earnings and adjusted ROE. Each of these companies has a market capitalisation in excess of $500m, and most of these companies are household names in Canada. All provide detailed and frequent financial disclosures. Figure 1 therefore provides us with a good starting point, but it fails to address our second consideration, which is valuation. Simply buying outstanding companies without consideration to value will substantially reduce one’s ability to outperform the market. While we don’t have the room in this note to perform detailed cash flow analysis of each of these companies, a current year’s P/E provides a reasonable measure of which stocks on our list are expensive and which are cheap. In Figure 2 we simply rank our list of 25 great companies by P/E (based on current price and DKAM’s estimates for 2013 cash earnings). CGI Gr oup, Home Capital and Horizon North emerge as the cheapest of our list of great Rank Company Ticker Industry Mkt Cap ($MM) ROAE 1 Sirius Satellite Radio XSR Satellite Radio 739 64.4% 2 Lululemon LLL Yoga Clothing 9,523 42.1% 3 Canexus CUS Terminal operations 985 40.9% 4 Macdonald Detwiler MDA Technology 2,014 39.2% 5 Norboard NBD Paper 1,921 36.9% 6 Constellation Software CSU Software 2,658 29.0% 7 CGI Group GIB.A IT services 7,317 27.8% 8 Rogers Communications RCI.B Telecoms 25,163 26.5% 9 Alimentation Couche-Tard ATD.B Convenience Stores 8,917 25.0% 10 Potash Corp POT Fertlizer 35,957 24.9% 11 Valeant Pharma VRX Pharma 19,567 24.6% 12 First Service FSV Services 881 23.3% 13 Open Text OTC Software 3,413 23.2% 14 Home Capital Group Inc. HCG Specialty Lender 2,107 23.1% 15 Horizon North Logistics HNL Oil and gas svcs. 684 22.4% 16 Intertape Polymer ITP Tape 525 22.3% 17 Tim Hortons THI Donuts and coffee 7,778 22.2% 18 High Liner Foods HLF Fish 499 21.9% 19 Jean Coutou PJC.A Pharmacy 3,244 21.0% 20 Agrium AGU Fertiliser 17,369 20.5% 21 Paladin Labs PLB Pharmaceuticals 897 19.9% 22 Parkland Fuel PKI Gas stations 1,308 19.4% 23 Stella - Jones SJ Wood products 1,115 18.7% 24 BMTC Group GBT.A Consumer goods 693 18.5% 25 Saputo SAP Milk and cheese 10,207 18.5% Figure 1 - High ROE stocks in Canada - Based on 2013 DKAM estimates

6 ROE REPORTER | DKAM business franchises. A useful way of looking at Figures 1 and 2 is to assume that the Figure 1 simply shows you the 25 best stocks to own while Figure 2 gives you an idea of wh ich of the 25 “best” are on sale this week. The last step is to look at the trade-offs between growth (ROE) and value (P/E). Once again, this ratio can be thought of as representing the number of units of growth one can buy per unit of value. In this context and absent of any other analysis, CGI Group ranks number one and provides an investor with 4.2 units of growth per unit of value. Typically the TSX trades on ROE to P/E ratio of 1:1 and thus CGI Group is approximately 4.2x more attractive than the TSX in aggregate. Rank Company Ticker Industry Mkt Cap ($MM) P/E 1 CGI Group GIB.A IT services 7,317 6.6 2 Home Capital Group Inc. HCG Specialty Lender 2,107 7.9 3 Horizon North Logistics HNL Oil and gas svcs. 684 8.6 4 High Liner Foods HLF Fish 499 10.1 5 Paladin Labs PLB Pharmaceuticals 897 10.2 6 Intertape Polymer ITP Tape 525 10.4 7 First Service FSV Services 881 10.4 8 Canexus CUS Terminal operations 985 10.8 9 Open Text OTC Software 3,413 11.0 10 Agrium AGU Fertiliser 17,369 11.3 11 Parkland Fuel PKI Gas stations 1,308 11.6 12 Macdonald Detwiler MDA Technology 2,014 11.6 13 Jean Coutou PJC.A Pharmacy 3,244 12.1 14 Norboard NBD Paper 1,921 12.7 15 Stella - Jones SJ Wood products 1,115 12.8 16 BMTC Group GBT.A Consumer goods 693 13.3 17 Alimentation Couche-Tard ATD.B Convenience Stores 8,917 13.6 18 Potash Corp POT Fertlizer 35,957 14.1 19 Rogers Communications RCI.B Telecoms 25,163 14.9 20 Constellation Software Inc. CSU Software 2,658 14.9 21 Tim Hortons THI Donuts and coffee 7,778 16.9 22 Sirius Satellite Radio XSR Satellite Radio 739 17.2 23 Valeant Pharma VRX Pharma 19,567 18.8 24 Saputo SAP Milk and cheese 10,207 20.0 25 Lululemon LLL Yoga Clothing 9,523 27.3 Figure 2 - High ROE stocks in Canada - Ranked by 2013 DKAM Estimated P/E Rank Company Ticker Industry Mkt Cap ($MM) ROE/PE 1 CGI Group GIB.A IT services 7316.95 4.2 2 Canexus CUS Terminal operations 985.161 3.8 3 Sirius Satellite Radio XSR Satellite Radio 738.6 3.8 4 Macdonald Detwiler MDA Technology 2013.894 3.4 5 Home Capital Group Inc. HCG Specialty Lender 2106.93125 2.9 6 Norboard NBD Paper 1920.996 2.9 7 Horizon North Logistics HNL Oil and gas svcs. 684.18 2.6 8 First Service FSV Services 880.85138 2.3 9 High Liner Foods HLF Fish 499.055 2.2 10 Intertape Polymer ITP Tape 525.3336 2.2 11 Open Text OTC Software 3413.4776 2.1 12 Paladin Labs PLB Pharmaceuticals 897.3639 2.0 13 Constellation Software Inc. CSU Software 2657.9645 1.9 14 Alimentation Couche-Tard ATD.B Convenience Stores 8917 1.8 15 Agrium AGU Fertiliser 17368.94 1.8 16 Rogers Communications RCI.B Telecoms 25162.62 1.8 17 Potash Corp POT Fertlizer 35956.665 1.8 18 Jean Coutou PJC.A Pharmacy 3244.24 1.7 19 Parkland Fuel PKI Gas stations 1308.384 1.7 20 Lululemon LLL Yoga Clothing 9522.72 1.5 21 Stella - Jones SJ Wood products 1114.63213 1.5 22 BMTC Group GBT.A Consumer goods 692.74625 1.4 23 Tim Hortons THI Donuts and coffee 7777.53 1.3 24 Valeant Pharma VRX Pharma 19567.275 1.3 25 Saputo SAP Milk and cheese 10207.3566 0.9 Figure 3 - High ROE stocks in Canada - Ranked by 2013 DKAM Estimated P/E

7 ROE REPORTER | DKAM Six Great Stocks for 2013 The preceding three figures have provided us with a good idea of where to look for both value and growth in the Canadian equity market in 2013. The next step is to look into the specific details of individual companies with the goal of finding a company that can consistently deliver above average earnings growth and whose shares can be acquired at a reasonable price. Some of the companies that appear on our lists will now fade from our discussion because they lack a reasonably long track record as a public company, are inconsistent performers or are too cyclical for our liking. The six companies that we know reasonably well and believe make for terrific investments in both the short- term and long-term are as follows; CGI Group (GIB.A) – Montreal based CGI Group is an IT services and consulting firm that employs more than 70,000 people in 40 countries. The Company has a strong track record of achieving high ROE’s as a result of growing earnings and share buy backs. The company has also been an astute acquirer, with the British Firm Logica being its most recent addition. CGI’s consistent track record and superb balance sheet management suggest that this stock will continue to perform well. CGI represents 10.8% of the DKAM Capital Ideas Fund. MacDonald Dettwiler (MDA) – is a Richmond, British Columbia based aerospace and IT Services Company which has shown a remarkable track record for innovation and profitability. The Company’s current focus is satellite communications, and its clients range from NASA to the Australian Defence Force. While MacDonald Dettwiler at times suffers from “lumpy” earnings, its high ROE and reasonable valuation make this a stock to own for the long run. MDA represents 2.1% of the DKAM Capital Ideas Fund. Figure 4 - CGI Group FYE Sep 2006A 2007A 2008A 2009A 2010A 2011A 2012E 2013E Rev ($MM) 3477.6 3633.0 3705.9 3825.1 3732.1 4323.2 4835.0 10395.5 Cash Earnings ($MM) 266.2 359.1 394.9 418.0 455.6 544.6 587.0 1031.0 Cash EPS ($) 0.40 1.15 1.30 1.47 1.71 2.05 2.28 3.38 Net margin (%) 4.2% 10.4% 11.1% 11.8% 13.0% 12.6% 12.1% 9.9% ROE* NA 21% 22% 21% 22% 24% 24% 22% Source: Donville Kent Figure 5 - MacDonald Dettwiler FYE Dec 2006A 2007A 2008A 2009A 2010A 2011E 2012E 2013E Rev ($MM) 1052.5 1204.2 1168.5 1000.9 688.0 761.1 870.6 1864.0 Cash Earnings ($MM) 92.996 103.967 73.69 115.386 135.308 163.791 120.5 183.1 Cash EPS ($) 2.25 2.55 1.82 2.84 3.34 5.15 3.79 5.75 Net margin (%) 8.8% 8.6% 6.3% 11.5% 19.7% 21.5% 13.8% 9.8% ROE* 23% 15% 22% 24% 39% 46% 55% Source: Donville Kent

8 ROE REPORTER | DKAM Home Capital Group (HCG) – Toronto based Home Capital Group is the largest independent Mortgage and Trust Company in Canada. The Company has been run by that same entrepreneur (Gerry Soloway) since the 1980’s and he has positioned the Company in a manner that allows it to grow while mitigating the risk of a possible real estate downturn. This risk mitigating strategy centers on one key concept and that is “low ratio lending”. Home Capital typically only lends the first 70% of a home’s value. Therefore, if a housing correction were to ensue, the downside risk to Home Capital would be small because the first loss would be absorbed by other lenders or the home owner. Home Capital’s ROE has stayed above 20% for nearly two decades and we expect that level of performance to continue in 2013. Home Capital represents 10.6% of the Capital Ideas Fund. High Liner Foods (HLF) – If you grew up in Canada, then you know about High Liner and their fish sticks – and I’m not ashamed to say that I loved them! Today Lunenburg, Nova Scotia based High Liner Foods is a leading North American processor and marketer of prepared frozen seafood. Over the past decade the Company has made a number of astute acquisitions that have transformed the Company into a major player in the North American seafood market. While the company’s historical ROE has been a bit below the level that would excite us, recent acquisitions (Viking Seafoods and Icelandic Group) will lead to higher margins and an ROE in the 20%+ range. High Liner Foods represents 5.6% of the DKAM Capital Ideas Fund. Paladin Labs (PLB) – Montreal based Paladin Labs is a Canadian specialty pharmaceutical company that has a strong track record for growth, ROE and acquisitions. Of particular interest to current investors in Paladin is its $250MM cash position which we expect to be deployed in the form on an acquisition or perhaps dividend. In fact, we see Paladin as such a strong cash flow generator that we believe the initiation of a significant dividend or buy Figure 6 - Home Capital Group FYE Dec 2006A 2007A 2008A 2009A *2010A 2011E 2012E 2013E Rev ($MM) 241.1 320.8 374.0 365.1 382.2 440.0 510.0 586.5 Cash Earnings ($MM) 67.8 90.2 108.7 144.5 180.9 208.0 239.2 264.5 Cash EPS ($) 1.99 2.62 3.15 4.19 5.21 5.99 6.89 7.64 Net margin (%) 28.1% 28.1% 29.1% 39.6% 47.3% 47.3% 46.9% 45.1% ROE* 27% 29% 28% 28% 30% 29% 26% 25% Source: Donville Kent (*2010 transition to IFRS) Figure 7 - High Liner Foods FYE Dec 2007A 2008A 2009A 2010A 2011E 2012E 2013E Rev ($MM) 275.3 615.9 627.2 584.7 668.6 1008.6 1109.5 Cash Earnings ($MM) 7.3 15.6 21.2 21.2 20.0 30.3 37.7 Cash EPS ($) 0.55 0.84 1.16 1.40 1.33 2.00 2.50 Net margin (%) 2.7% 2.5% 3.4% 3.6% 3.0% 3.0% 3.4% ROE* 13% 13% 14% 13% 18% 20% Source: Donville Kent

9 ROE REPORTER | DKAM back is inevitable. Regardless, we think Paladin represents a growth stock with superb risk mitigating features. Paladin represents 10.9% of the Capital Ideas Fund. Constellation Software (CSU) – Toronto based Constellation Software is a leading provider of software and services to a select group of public and private sector markets. The management team at Constellation might also be the best allocator of capital in corporate Canada. Over the past six months, Constellation has made a number of acquisitions and given their track record, we can expect another year of robust growth and high ROE in 2013. Constellation Software represents 12.7% of the Capital Ideas Fund. Figure 8- Paladin Labs FYE Dec 2006A 2007A 2008A 2009A 2010A 2011E 2012E 2013E Rev ($MM) 48.4 62.9 82.7 109.7 128.0 141.5 209.2 283.2 Cash Earnings ($MM) 13.1 21.5 26.4 62.8 52.7 72.2 77.6 82.9 Cash EPS ($) 0.88 1.43 1.78 3.71 2.82 3.61 3.80 4.08 Net margin (%) 27.1% 34.2% 31.9% 57.3% 41.2% 51.0% 51.3% 50.8% ROE* 19% 28% 30% 43% 25% 26% 20% 17% Source: Donville Kent Figure 9 - Constellation Software FYE Dec 2006A 2007A 2008A 2009A 2010A 2011E 2012E 2013E Rev ($MM) 210.8 243.0 330.5 437.9 634.0 773.3 836.8 925.3 Cash Earnings ($MM) 15.9 33.5 57.6 70.8 97.9 233.8 155.0 178.3 Cash EPS ($) 0.76 1.59 2.73 3.35 4.62 11.03 7.31 8.41 Net margin (%) 7.5% 13.8% 17.4% 16.2% 15.4% 30.2% 18.5% 19.3% ROE* NA 40% 63% 68% 76% 117% 55% 53% Source: Donville Kent

10 ROE REPORTER | DKAM Final Thoughts The market crash of 2008 led to a huge shift of assets out of equities into low risk assets, such as bonds, REITS, Convertible Bonds, and the like. Sometime not too far in the future, the pendulum will reverse and there will be a similarly massive move back into equities. Nobody knows with any certainty when this will occur, as these kinds of moves will only appear obvious once they are well underway. But it’s going to happen. The bottoming in the US residential market might be the trigger. Much of the ma rket’s psychology is based upon the “wealth effect” which in turn is based in large part on the value of one’s largest asset, namely the house that one lives in. The US residential market has now bottomed and this has given a tremendous boost to market psychology. Because the residential real estate market has bottomed, many investors are beginning to feel more comfortable with the strength and capabilities of major financial institutions in the US and Canada. And so it goes. There is a positive feel to the market and I think 2013 will be a good year for equity investors. Call me or write me if you want to chat – J.P. Donville ( Jason@donvillekent.com ;416-364-8886)