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.

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

Figure 1 – 15 Year Track Record of one of Canada’s Best Fund Managers

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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 Group Inc (TSE:HCG) (OTCMKTS:HMCBF), 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.

donville kent home capital stock

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.

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See full Donville Kent: A Tale Of Two Ships in PDF format here.