Jason Donville, whose fund has outperformed Canadian stocks for five years using Warren Buffett’s value investing strategy, is eyeing Pulse Seismic (PSD) Inc., Total Energy Services Inc. (TOT) and other energy stocks after the recent resources rout.
“We’re sharpening our pencils on energy right now because it’s very bombed out and the summertime is a great time to go looking for bargains,” said Donville, chief executive officer at Donville Kent Asset Management Inc. in Toronto.
His DKAM Capital Ideas Fund, a hedge fund with about C$70 million ($69.4 million) under management, has produced an average annual return of 24 percent since its inception in October 2008, compared with a 2.9 percent average return for the Standard & Poor’s/TSX Composite Index in the same period, according to Donville Kent’s website.
The S&P/TSX rose 0.3 percent to 12,360.15 at 11:48 a.m. today in Toronto.
Donville, 49, a former analyst for Credit Lyonnais in Asia and a one-time watchkeeper on submarines for Canada’s navy, targets value stocks that trade at low prices relative to earnings yet report high returns on equity.
“It’s Buffettology, for lack of a better word,” Donville said in an interview at Bloomberg’s Toronto bureau on April 30. “Return on equity is the centerpiece of everything I do. ROE is really important because it’s a measure of how fast the company is growing.”
Return on equity, or net income relative to shareholders’ equity, is a measure of how well a company uses reinvested earnings to generate more profit.
Donville’s fund has returned 8.4 percent this year, outperforming the asset-weighted Scotiabank Canadian Hedge Fund Index, a gauge of open and closed funds with assets of at least C$15 million and a 12-month track record, which has risen 2 percent in 2013.
DKAM’s top three holdings, Constellation Software Inc. (CSU), CGI Group Ltd. (GIB/A) and Paladin Labs Inc (PLB), which have returned 43 percent, 43 percent and 22 percent respectively in the past 12 months, all fit Donville’s criteria of ROE greater than 20 percent with price-to-earnings ratios in the single digits, he said. CGI is a Montreal-based technology services company; Constellation is a Toronto-based software maker and Paladin is a drugmaker in Montreal.
“We’re looking for the CGIs of the world,” he said. “We simultaneously want growth and quality and want it tied up in a single metric.”
CGI Group surged to a 13-year high of C$31.90 on April 30 after reporting profit ahead of analysts’ estimates.
The fund manager said he sold his shares of Argonaut Gold Inc. and B2Gold Corp., as well as a stake in Potash Corp. of Saskatchewan Inc., about four weeks before an April 15 collapse in commodities. Prices fell the most since 2008, including the biggest drop for gold since 1980 that pushed the metal into a bear market. Crude fell to its lowest since December.
“The resource trade was busted,” Donville said. “We’re in the eighth inning of a five-year cycle. There are two things you want to be light on, the resource stocks and historically the financials.”
Donville is weighing an investment in Pulse Seismic, a Calgary-based company that licenses two and three-dimensional seismic data to energy companies.
“We love knowledge-based businesses,” Donville said. “Fifteen years ago 30 guys had seismic libraries, and Pulse has quietly bought them all up and now they’ve got that critical mass.”
Technology stocks currently account for about 28 percent of Donville’s portfolio including Constellation, CGI Group, Enghouse Systems Ltd. (ELS) and MacDonald Dettwiler & Associates Ltd. all in the fund’s Top 10 holdings. Enghouse is a software company in Markham, Ontario and MacDonald Dettwiler is a satellite company in Vancouver.
What they have in common is a focus on steady growth towards domination of an industry via expansion and acquisitions, as opposed to constant innovation -- a nuance often lost on technology investors and analysts, he said.
“I approach these companies as an economist,” he said. “That’s the secret to looking at them. It has more to do with oligopolies. So much about software is once it gets embedded, you have a very sticky relationship with your customers. Analysts miss this because they get preoccupied with the technology.”
BlackBerry, which Donville doesn’t own and has no plans to buy, once dominated the cellphone landscape with its line of e- mail enabled smartphones. The Waterloo, Ontario-based company fell behind as Apple Inc. and Google Inc. entered the market with new smartphone and tablet technologies. The stock has plunged 88 percent in the past five years, the second-worst performing stock in the S&P/TSX in that period.
BlackBerry has soared 35 percent this year as some investors bet on strong sales of the new Q10 device, which CEO Thorsten Heins said this week could be in the ‘tens of millions.’’
Rebecca Freiburger, a spokeswoman with BlackBerry, declined to comment on the company’s strategy.
Donville’s top holding is Constellation Software, which accounts for about 15 percent of his portfolio. The software holding company acquires smaller businesses, typically with revenue of less than C$25 million, that specialize in developing technology for niche areas such as health and leisure clubs and tourist attractions.
Constellation has soared sixfold in the past five years as of May 1, the third-best performing stock in the S&P/TSX in that time. Montreal-based CGI Group, the No. 2 holding, specializes in information-technology services including management and consulting.
“Buffett has always said, ‘Oh, I don’t understand technology, even though I play Bridge with Bill Gates,’” and owns shares in IBM Corp., Donville said. Berkshire Hathaway Inc. is the largest shareholder (IBM:US) of IBM, with a 6.1 percent stake in the Armonk, New York-based company.
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