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Great niche, great management and a very high return on capital

Home Capital CEO Gerald Soloway

JENNIFER ROBERTS/jennifer roberts The Globe and Mail

The investor:

J.P. Donville, president and CEO, Donville Kent Asset Management Inc.

The investment:

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Home Capital Group

The background:

"I first invested in Home Capital, which was, and still is, a mortgage lender, around 2000.

"At the time, the company had a very high return on capital, and, when I met the management team, I was really impressed with how on top of the industry the CEO and his supporting cast were.

"The CEO is Gerald Soloway. He, Roy Pincent, Nick Kypriano and Cathy Sutherland were the brain trust of Hope Capital in 2000. It was a very entrepreneurial management team that was operating between the cracks of where the major banks were operating, doing mortgage lending to people who didn't qualify for mortgages from banks, but were still relatively low-risk lending candidates.

"They were lending to immigrants who hadn't been in Canada long enough to qualify for regular bank mortgages. These people could have a prime background in England, or Pakistan, or wherever, but hadn't been here long enough to qualify, and the company knew that immigrants are just fantastic people to lend to. Immigrants don't show up in Canada to go bankrupt, they come to Canada determined to make it.

"Also, they were lending to people who were self-employed entrepreneurs who didn't have proof of income. These people were asset-rich, but they didn't have T-4 slips to show that they had massive incomes. But, if you analyzed their businesses, you could see that they had strong cash flow.

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"That was why this company was so fascinating - they had a great lending market, almost like a subprime market from a pricing point of view, but the underlying risk of their borrowers was quite low.

"So you had this great niche, you had this great management team and you had a very high return on capital. And at the time I was looking at the company, it had a P/E ratio of six or seven times."

The return:

"At the time, I was working as an analyst, so I was looking for companies to pick up as an analyst. I ended up picking up coverage of this company. And I wasn't just recommending that other people buy the stock, I bought it myself.

"Two wonderful things happened: First, on an adjusted basis, the stock went from about $1.50 in 2000 to approximately $45.

"Second, as a financial services analyst, it was a huge reputation maker - it was the huge win of the decade. It was always my top pick. It was always my favourite stock. My name became synonymous with Home Capital.

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"I got a double win out of it. I got the huge upside in the stock, because I invested in the stock myself, but also the company made me look really good as an analyst. The term is 'reputational franchise' - my reputation as an analyst was enhanced by this recommendation."

The takeaway:

"No. 1: The company had a high return on equity, which is basically the compounding rate of an investment, and if you can find companies that compound at a high annual rate, that's the secret to making money in the long run.

"No. 2. High ROE businesses generally have a big moat built around them - a safety cushion - and Home Capital is a perfect illustration: It's a high ROE company with a great big moat around it.

"No. 3: Quality of management is extremely important. In this case, I recognized a superb management team 10 years ago, and I would argue that they're still among the best in the business today - they're really focused and really entrepreneurial.

"I still own the stock today, and I've been buying it recently. Ten years later, I still love the company."

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