A tale of two ships 2013 was a solid year for Canadian equity investors and a strong year for the Capital Ideas Fund. The TSX Composite rose 9.6% while the Capital Ideas Fund was up 51.6% for the year. In 2013, the key portfolio decision we made was to lighten up, at the start of the year, on natural resource stocks – gold, metals, energy and agriculture. This allowed us to benefit from the surge in non-resource stocks that occurred throughout the year while avoiding the pounding that endured for natural resource stocks for most of 2013. For 2014, we expect another positive year for equity investors but doubt that this year will be as strong as 2013. Valuations have expanded significantly since the market bottom in 2009 and bargains are now getting harder to find. As such, we have positioned the portfolio a bit more conservatively than in past years. Regardless of how we think the market will perform in 2014, we will continue to focus our investment strategy on a small basket of companies that we think are capable of delivering superior returns on shareholders equity over extended periods of time. We think that security selection (i.e. stock picking) is more important than market timing. And that is not to say that market timing isn’t valuable. It certainly is if one could actually do it, but people like Warren Buffett don’t believe it is possible – and neither do we. Thus, our strategy remains focused on owning outstanding companies that can deliver high ROE’s in all economic environments. VOLUME XXV JANUARY 2014 INVESTMENT ISSUES • STRATEGIES • INSIGHTS FROM DONVILLE KENT

2 ROE REPORTER | DKAM The goal of every investor Imagine that 15 years ago (1998) you came across a fund manager with whom you invested with and subsequently she (he) delivered the following returns These returns are indeed pretty spectacular and the manager of this fund in fact exists. However, before I reveal the identity of the said fund manager, let me point out that his “fund” consists of the net assets or shareholders equity of a public company and the manager in question does not manage an investment fund per se. The manager in question is Gerry Soloway and he is the CEO of Home Capital, a federally regulated trust company based in Toronto, Ontario. To once again reiterate, the returns laid out in Figure 1 are not the performance of a fund; they are the return on equity (ROE) of Home Capital. However, over time the return of a stock and its ROE tend to coincide quite nicely. To confirm this point, we note that on the first of January, 1998 Home Capital’s share price was $1.63 and today it is roughly $80.00. Excluding dividends, the stock is a 49 bagger over the past sixteen years. However, Home Capital has been paying a dividend since 1999 and thus, including dividends; the stock has appreciated at a CAGR of 28% over the same time frame. Figure 1 - 15 Year Track Record of one of Canada's Best Fund Managers Year Annual Return 1998 20.7% 1999 21.8% 2000 23.2% 2001 23.8% 2002 24.3% 2003 27.4% 2004 31.4% 2005 31.8% 2006 27.4% 2007 28.9% 2008 27.8% 2009 28.2% 2010 27.3% 2011 27.1% 2012 25.5%

3 ROE REPORTER | DKAM The “Holy Grail” of equity investors are companies like Home Capital that have as their key attribute the ability to consistently earn an ROE of 20% or better. Once you have found such a company to invest in, the related goal is to hold this stock or basket of stocks for as long as the Company can achieve said returns. Easier said than done, but nonetheless achievable. At the start of each year, I write about a few stocks that I believe should be the focus of a long- term investor’s portfolio. The 2014 list appears later in this newsletter while my past pics are listed below. The purpose of Figure 3 is not to gloat about past picks but to point out that many of our past picks, which also happen to have been our largest positions at the time, have been on our favorites list for years. Rest assured that my picks for 2014 look a lot like my picks for 2013. Quality of management A significant part of the story of the great franchise stocks that we focus on each year is quality of management. CEO’s like Mark Leonard (Constellation Software) , Gerry Soloway (Home Capital), Jonathan Goodman (Paladin Labs), Claude Roy (Logibec and now Mediagrif) and Stanley Ma (MTY Food Group) only to name a few, are business leaders of great integrity and skill who have and continue to deliver superior returns to their investors. Of course, most investors believe that quality of management is important but like me they struggle at times to find ways to measure it. This issue is particularly challenging for Do-it-yourself (DIY) investors who rarely if ever meet with management teams. I first encountered the challenge of rating management teams many years ago. Fresh out of business school in 1992, I began work as an equity analyst in Singapore and one of the first lessons I learned as an analyst was not to confuse affability with quality. My first job in Singapore involved writing equity research on ship repair companies such as Sewbawang, Keppel, Hitachi Zosen and Jurong, along with shipping companies such as Neptune Orient Lines and Pacific Carriers. I was assigned coverage of the marine sector in part because of my previous background as a Naval Officer. It was assumed (correctly) that I had a genuine interest in ships and their repair facilities. Further, my ability to tell “salty dips”, the naval euphemism for a good story, with th e CEO’s of marine based companies who had also spent time in their youth at sea allowed me to quickly build a rapport with key management Figure 3 - Past DKAM Franchise Stocks 2010 2011 2012 2013 2014 Constellation Software Constellation Software Constellation Software Constellation Software ? MTY Food Group MTY Food Group CGI Group CGI Group ? Paladin Labs Paladin Labs Paladin Labs Paladin Labs ? Logibec Home Capital Home Capital Home Capital ? Glentel Glentel High Liner Foods ? MacDonald Dettwiler ?

4 ROE REPORTER | DKAM teams. On the surface, I really looked like I knew my stuff – until it was obvious that I didn’t. As a young analyst, I somehow equated the friendliness of certain management teams with the level and quality of their management skills. Thus, in my naivety the management teams running companies such as Sembawang Shipyards and Pacific Carriers were assumed to be the best (which I would soon learn was not true), while the always grumpy K.K. Tan, CEO of Jurong Shipyard, was assumed to be merely OK, when in fact he turned out to be the best of the bunch. Within a few years of becoming an analyst I began to realise that quality of management is critically important to the long-term success of a company and it was at that time that I began to look for ways to objectively measure it. Here are my thoughts on the subject. 1. Assessing the quality of management from the outside is difficult – Many investors and pundits will extoll the virtues of a particular management team without really having any objective basis for doing so other than by noting that the Company’s stock has gone up. Assessing the quality of management is difficult but it can be done. Those who are REALLY good at assessing managerial capabilities look for objective measures and/or quantifiable measures to go along with more subjective measures. 2. Long-term track record is EXTREMELY important – One or two year snap shots in time tell you very little about a company or its management because even mediocre companies and mediocre management teams have a good year once in a while. If you want to assess a management team, look at the last five years of track record and if you can go back longer than do so. It’s surprising how obvious certain trends can be to spot in a Company when you lay its past history out in a manner that allows one to move easily from year to year. Once you have the 5 year (or longer) track record in front of you, focus on three or four key factors that are important to YOU! For me, the three key line items I would look at are; 1) ROE, 2) Sales Growth and 3) Share issuance. Any management team can achieve a high ROE for a year or two but doing it for 5 years in a row or more takes a great deal of skill because the profits from the first high ROE year must be intelligently redeployed in the business or the ROE will begin to fall quickly. Any company that can maintain an ROE in excess of 15% per annum while growing sales at a high rate (10% or better per annum) and do so without issuing more shares is probably one that is run by a strong management team. To achieve all three of these items at the same time is actually a rare feat and suggests that a very skilled management team is in place. 3. Working capital management is another key way to look inside the business – For investors who have a bit more financial or educational training, performing an analysis of a company’s key working capital ratios will give yo u an idea of whether or not the company is in ship-shape or not. Here we are talking about inventory turnover, accounts payable and receivable management, and cash

5 ROE REPORTER | DKAM management. Management teams that are on top of the details tend to be quite efficient at keeping working capital low and/or efficient. Ideal levels of working capital differ from industry to industry but with a little bit of effort it will become obvious which companies are sharp and which are bloated or sloppy. My experience is that such sharpness or sloppiness in terms of working capital management transcends other areas of the business. 4. Attend the AGM, listen to management and make notes – Most DIY investors do not have direct access to management but they can listen in on conference calls and attend the Annual General Meeting. For the DIY investors, attending an AGM is both a wonderful social and educational experience and also a chance for you to ask questions directly of management. During the AGM, many questions will be asked and you should be attuned to any discussion regarding the 2-3 key goals or challenges facing the company at this stage in its history. For the long- term investor, you should make notes of what those two or three issues are and then ask yourself “if I couldn’t speak wi th management, how would I measure the company’s progress on achieving its key goals or solving its issues”. If you return for the next AGM, ask management to give an accounting of how they did in relation to the goals or issues they were trying to address the year before. If you follow this process with the companies you own, you will quickly see which management teams are really sharp and which are ordinary. The four points I have described above should provide investors who do not have frequent and easy access to management teams with some ways of assessing how well their management teams performed. For investors who wish to go beyond these four points, perhaps the best checklist for rating management can be found in Common Stocks and Uncommon Profits by Phillip Fisher. The best part of the book is Fisher’s “Fifteen Points to look for in a Common Stock” and the bulk of Fishers points are managerial in nature. Warren Buffett considers Fisher’s book, which is available in bookstores everywhere, to be among the most important he has ever read. I think the book is still highly relevant to investors who want to buy stocks and think like an owner of business and not simply a holder of share certificates. Looking for great companies in 2014 The Capital Ideas Fund is built around the idea that the best stocks to own are those that can earn a consistently high ROE without resorting to accounting gimmickry or excessive amounts of leverage. The best way to look for such companies is by preparing a list of those companies that are earning a high ROE in their current financial year. Figure 4 below presents the best companies in our database based on projected Return on Average Equity (ROAE) for 2014 using DKAM estimates and adjusted for cash earnings and dividends.

6 ROE REPORTER | DKAM Figure 4 a gives us a good idea of what kinds of companies are performing well in 2014 but it doesn’t address valuation. In figure 5 below, we rank the same list of 25 companies from cheapest to most expensive in terms of P/E ratios. As is the case each year when we present this list, there are always a few companies trading at remarkably low P/E ratios and a few that appear to be quite expensive. Rank Company Ticker Industry Mkt Cap ($MM) ROAE* 1 Constellation Software CSU Technology/Software 4897.7 55% 2 Gluskin Sheff GS Asset Manager 829.1 52% 3 Macdonald Dettwiler MDA IT/Space/Technology 2862.0 37% 4 Valeant Pharma VRX Pharma 50879.0 35% 5 Avigilon AVO Technology/Software 1095.7 35% 6 Intertape Polymer ITP Tape 755.5 31% 7 Yellow Media Y Advertising 769.1 30% 8 First Service FSV Services 1382.1 28% 9 Tim Hortons THI Donuts and coffee 8129.0 27% 10 Auto Canada Inc ACQ Auto-Finance 940.7 24% 11 CGI Group GIB.A IT services 10807.3 24% 12 Rogers Communications RCI.B Telecoms 24591.3 24% 13 Mitel Networks MNW Network 1099.8 23% 14 Alimentation Couche-Tard ATD.B Convenience Stores 14979.9 22% 15 MTY Foods MTY Food franchising 610.7 22% 16 Element Financial EFN Financial Services 2109.4 21% 17 Open Text OTC Software 5859.4 21% 18 Home Capital Group Inc. HCG Specialty Lender 2777.0 21% 19 Saputo SAP Milk and cheese 10771.0 21% 20 High Liner Foods HLF Fish 717.3 20% 21 Dollarama DOL Retailing 6261.8 20% 22 Enghouse ESL Software 880.2 20% 23 Badger Daylighting BAD Industrial (Daylighting) 1173.2 20% 24 Norbord NBD Forest Products 1318.0 20% 25 Canadian Pacific Railway CP Railways 28235.3 20% * return on average equity, based on cash earnings and adjusted for dividends Figure 4 - High ROE Stocks in Canada - Based on 2014 DKAM estimates

7 ROE REPORTER | DKAM Figure 5 shows us which companies are reasonably valued and which ones are expensive but as investors we really want to maximize ROE while minimizing cost. In Figure 6 we combine both ROE and P/E, so that we can see where the best trade-off occurs. Interestingly, some of the best growth names in Canada still trade at a reasonable Growth/PE ratio. We consider any stock with a ratio of 2.0 or better to be highly attractive and any stock at 1.0 or lower to be fully valued. Investors should also note that Figures 4, 5 and 6 only look at a single year of data, and therefore should only be used as a starting point in terms of one’s investment due diligence. Rank Company Ticker Industry Mkt Cap ($MM) PE 1 Yellow Media Y Advertising 769.1 3.8 2 Norbord NBD Forest Products 1318.0 8.6 3 Home Capital Group Inc. HCG Specialty Lender 2777.0 9.3 4 CGI Group GIB.A IT services 10807.3 9.6 5 Intertape Polymer ITP Tape 755.5 10.8 6 Gluskin Sheff GS Asset Manager 829.1 11.1 7 Rogers Communications RCI.B Telecoms 24591.3 12.5 8 Mitel Networks MNW Network 1099.8 12.7 9 High Liner Foods HLF Fish 717.3 12.9 10 First Service FSV Services 1382.1 13.1 11 Macdonald Dettwiler MDA IT/Space/Technology 2862.0 13.6 12 Open Text OTC Software 5859.4 15.9 13 Saputo SAP Milk and cheese 10771.0 16.1 14 Constellation Software CSU Technology/Software 4897.7 16.3 15 Tim Hortons THI Donuts and coffee 8129.0 16.3 16 MTY Foods MTY Food franchising 610.7 16.9 17 Alimentation Couche-Tard ATD.B Convenience Stores 14979.9 18.0 18 Enghouse ESL Software 880.2 18.7 19 Canadian Pacific Railway CP Railways 28235.3 19.2 20 Element Financial EFN Financial Services 2109.4 19.2 21 Auto Canada Inc ACQ Auto-Finance 940.7 19.2 22 Valeant Pharma VRX Pharma 50879.0 19.7 23 Dollarama DOL Retailing 6261.8 21.7 24 Badger Daylighting BAD Industrial (Daylighting) 1173.2 25.3 25 Avigilon AVO Technology/Software 1095.7 30.9 Figure 5 - High ROE Stocks in Canada - Ranked by 2014 DKAM Estimated P/E

8 ROE REPORTER | DKAM Great franchise stocks to own for 2014 The preceding discussion has meant to serve as a lead in to our discussion regarding the best franchise stocks to own in 2014. Before we launch into Company specific analysis, it has sometimes been asked why I choose certain companies from our list and not others, particularly if they appear to meet our ROE and P/E requirements. The answer typically is either a poor track record or cyclicality. Some companies tend to have a pattern of earnings which I call “good year, bad year”. Such companies appear in our screens but their lack of consistent track record over the years prevents us from owning the stock or recommending it to others. The second type of company is the cyclical company, which will often appear attractive at the peak of the company’s economic cycle, when in fact we know the stock is actually expensive. Each of the stocks that I discuss subsequently are ones that I think are reasonably priced, have good track records and can perform well in all economic environments. Constellation Software – Is a Toronto based software company and is arguably run by the most astute management team in Canada. The company is a leading provider of software and services to public and private sector markets and close to 90% of its revenue is now derived from outside of Canada. The Company is led by Mark Leonard who has skillfully guided the Company Rank Company Ticker Industry Mkt Cap ($MM) ROAE/PE 1 Yellow Media Y Advertising 769.1 7.9 2 Gluskin Sheff GS Asset Manager 829.1 4.7 3 Constellation Software CSU Technology/Software 4897.7 3.4 4 Intertape Polymer ITP Tape 755.5 2.8 5 Macdonald Dettwiler MDA IT/Space/Technology 2862.0 2.7 6 CGI Group GIB.A IT services 10807.3 2.5 7 Norbord NBD Forest Products 1318.0 2.3 8 Home Capital Group Inc. HCG Specialty Lender 2777.0 2.3 9 First Service FSV Services 1382.1 2.1 10 Rogers Communications RCI.B Telecoms 24591.3 1.9 11 Mitel Networks MNW Network 1099.8 1.8 12 Valeant Pharma VRX Pharma 50879.0 1.8 13 Tim Hortons THI Donuts and coffee 8129.0 1.6 14 High Liner Foods HLF Fish 717.3 1.6 15 Open Text OTC Software 5859.4 1.3 16 Saputo SAP Milk and cheese 10771.0 1.3 17 MTY Foods MTY Food franchising 610.7 1.3 18 Auto Canada Inc ACQ Auto-Finance 940.7 1.3 19 Alimentation Couche-Tard ATD.B Convenience Stores 14979.9 1.2 20 Avigilon AVO Technology/Software 1095.7 1.1 21 Element Financial EFN Financial Services 2109.4 1.1 22 Enghouse ESL Software 880.2 1.1 23 Canadian Pacific Railway CP Railways 28235.3 1.0 24 Dollarama DOL Retailing 6261.8 0.9 25 Badger Daylighting BAD Industrial (Daylighting) 1173.2 0.8 Figure 6 - High ROE Stocks in Canada - Based on 2014 ROAE/PE estimates

9 ROE REPORTER | DKAM since start-up. We expect the Company to grow by close to 35% in 2014. Constellation Software remains our largest position with a 13.6% weighting in the Capital Ideas Fund. MacDonald Dettwiler – Is a Vancouver based technology company with operations that include satellite communications, space exploration, surveillance, and robotics. The Company is one of the few truly high technology companies listed on the TSX and while its annual profits tend to be a bit lumpy, its ROE consistently exceeds the 20% level. We expect the Company to grow by 37% in 2014 and it represents a 3.3% weighting in the Capital Ideas Fund. CGI Group – CGI Group is a Montreal based multinational information technology consulting, systems integration, outsourcing and solutions company. The Company has achieved an ROE in excess of 20% in nine of the last ten years and is currently one of the most reasonably priced High-ROE stocks in Canada. While CGI has its detractors, we believe the company will continue to deliver strong returns to investors via its ongoing operations, acquisitions, and share buybacks. CGI represents 9.2% of the Capital Ideas Fund. Figure 7 - Constellation Software Inc. FYE Dec 2007A 2008A 2009A 2010A 2011A 2012A 2013E 2014E Rev ($MM) 243.0 330.5 437.9 634.0 773.3 891.2 1179.0 1414.8 Cash Earnings ($MM) 33.5 57.6 70.8 97.9 158.8 177.8 243.8 290.7 Cash EPS ($) 1.59 2.73 3.35 4.62 7.49 8.39 11.50 13.72 Net margin (%) 14% 17% 16% 15% 21% 20% 21% 21% ROAE* 40% 63% 68% 76% 80% 69% 93% 55% Source: Donville Kent Figure 8 - MacDonald Dettwiler & Associates Ltd. FYE Dec 2007A 2008A 2009A 2010A 2011A 2012A 2013E 2014E Rev ($MM) 1204.2 1168.5 1000.9 688.0 761.1 879.9 1846.0 2080.0 Cash Earnings ($MM) 104.0 73.7 115.4 135.3 163.8 96.3 142.0 218.2 Cash EPS ($) 2.55 1.82 2.84 3.34 5.15 3.02 3.94 6.06 Net margin (%) 9% 6% 12% 20% 22% 11% 8% 10% ROAE* 23% 15% 22% 24% 39% 38% 32% 37% Source: Donville Kent Figure 9 - CGI Group, Inc. FYE Sep 2007A 2008A 2009A 2010A 2011A 2012A 2013A 2014E Rev ($MM) 3633.9 3705.9 3825.2 3732.0 4223.9 4772.5 10084.6 10400.0 Cash Earnings ($MM) 378.3 413.1 450.5 486.0 571.1 587.0 649.8 1222.4 Cash EPS ($) 1.17 1.34 1.53 1.79 2.19 1.91 2.09 3.97 Net margin (%) 10% 11% 12% 13% 14% 12% 6% 12% ROAE* 21% 22% 21% 22% 25% 20% 17% 24% Source: Donville Kent

10 ROE REPORTER | DKAM Home Capital – Toronto based Home Capital is the holding Company for Home Trust which is a federally regulated trust company offering deposit, mortgage lending, retail credit and credit card issuing services. Over the past twenty years, Home Trust has never achieved an ROE of less than 20%. Home Capital represents 7.6% of the Capital Ideas Fund. Valeant Pharmaceuticals – Montreal based Valeant Pharmaceuticals is a multinational specialty pharmaceutical company with a focus on branded pharmaceuticals, branded generics and over-the-counter products. The company was created in 2010 via the merger of Valeant and Biovail and is now one of the fastest growing speciality Pharmaceutical companies in the world. We expect the Company to grow by at least 35% in 2014. Valeant holds a 9.6% weighting in the Capital Ideas Fund. Figure 10 - Home Capital Group Inc. FYE Dec 2007A 2008A 2009A 2010A 2011A 2012A 2013E 2014E Rev ($MM) 188.3 224.6 277.6 308.8 361.3 422.7 496.0 580.3 Cash Earnings ($MM) 90.3 109.4 145.4 181.0 190.8 228.7 262.9 305.2 Cash EPS ($) 2.62 3.17 4.22 5.22 5.50 6.59 7.57 8.78 Net margin (%) 48% 49% 52% 59% 53% 54% 53% 53% ROAE* 29% 28% 28% 27% 27% 26% 24% 21% Source: Donville Kent (*2010 transition to IFRS) Figure 11 - Valeant Pharmaceuticals International, Inc. FYE Dec 2007A 2008A 2009A 2010A 2011A 2012A 2013E 2014E Rev ($MM) 842.8 757.2 820.4 1181.2 2463.5 3546.6 5750.0 8250.0 Cash Earnings ($MM) 243.6 251.3 281.2 11.4 717.4 812.9 695.0 2577.0 Cash EPS ($) 1.51 1.57 1.78 0.06 2.35 2.66 2.08 7.72 Net margin (%) 29% 33% 34% 1% 29% 23% 12% 31% ROAE* 19% 20% 22% 0% 16% 21% 15% 35% Source: Donville Kent

11 ROE REPORTER | DKAM Final Thoughts The global economy appears to be on a good footing but there are as always risks. I think we are in for a long period of modest growth and modest inflation. Stocks and markets will go up and down but when I look at the various asset classes from a high, I still think that equities are the place to be. We did well in 2013 but as I write this note in early January 2014, I want you to know that I’m not feeling complacent. Preserving your capital and making it grow remains my top priority. Call me or write me if you want to chat – J.P. Donville Jason@donvillekent.com - 416-364-8886