Chris Senyek, CFA, CPA

Head of Macro Research Chief Investment Strategist 646-845-0759 CSenyek@wolferesearch.com

Chip Miller, CFA, CPA 646-845-0752 CMiller@wolferesearch.com

Adam Calingasan, CFA, CPA 646-845-0757 ACalingasan@wolferesearch.com

Portfolio Strategy Weekly Audio: Time to Focus on ROE

A Stable Growth Update

A 5 Minute Audio Brief

DO NOT FORWARD – DO NOT DISTRIBUTE – This report is limited solely for the use of clients of Wolfe Research. Please refer to the DISCLOSURE SECTION located at the end of this report for Analyst Certifications and Other Disclosures. For Important Disclosures, please go to www.WolfeResearch.com/Disclosures or write to us at Wolfe Research, LLC, 420 Lexington Avenue, Suite 648, New York, NY 10170

February 24th 2015

2

Pushing Out the Biggest Risk to our Bullish Call

Notes: We classify the market cycle based upon the rate of change in a three month moving average of the Conference Board’s Leading Economic Index. We have made some manual adjustments around the mid-90’s EM crisis and 1998 Russian debt crisis, given the market began to ‘look through’ economic weakness much sooner than usual during these time periods. Notably, we have made no adjustments to our framework for the late-90s TMT bubble or around the 2008-2009 Financial Crisis. Sources: Wolfe Research Portfolio Strategy, Standard & Poor’s, Compustat, Thomson Financial, and FactSet.

• We remain confident that rising global liquidity will result in additional dollar strength, low and range bound interest rates, and higher stock prices in the months ahead.

• Last week’s most important development was more dovish than expected January FOMC minutes, which reduced one of the key risks to our bullish market view.

Fed Funds Futures: Implied Interest Rate Probabilities

Rate Hike Expectations Were Pushed Out Last

Week

This Reduces the Biggest Risk to Our

Bull Case

3

Risk Spreads Also Falling

Sources: Wolfe Research Portfolio Strategy, Bloomberg, Standard & Poor’s, Compustat, Thomson Financial, and FactSet.

• As oil has stabilized and as the global growth outlook has modestly improved, important measures of market risk/stress have fallen in recent weeks.

• Currently one of our favorite thematic ROE baskets is our ‘Stable Growth’ screen, which has been the second best performing stock theme that we track year-to-date.

4

Key Investment Themes

Notes: Market data as of 2/19/2015. Sources: Wolfe Research Quantitative Research, Standard & Poor’s, Company filings, Bloomberg, and FactSet.

5

BUY ‘STABLE GROWTH’ COMPANIES

Sources: Wolfe Research Portfolio Strategy, Standard & Poor’s, Bloomberg, Compustat, Thomson Financial, and FactSet.

• Most of our favorite ‘early’ forward indicators, such as the ZEW U.S. Economic Expectations index, strongly suggest that U.S. growth is decelerating; and (2) U.S. economic surprises have turned decidedly negative over the past five weeks.

• However, we believe rising global liquidity and the positive effects of lower oil (on spending) will minimize further downside risk to growth in 2015.

Our favorite early

forward indicator

— the U.S. ZEW —

strongly suggests

decelerating

growth ahead

We’re not

calling for the end

of the cycle

However, we

remain confident

in our below

consensus 2015

U.S. GDP forecast

of 2.5%

6

Rising ZEW Suggests Rising Market ROE

Sources: Wolfe Research Portfolio Strategy, Standard & Poor’s, Compustat, Thomson Financial, and FactSet.

• The rebound in ROEs should be supportive of multiple expansion in the quarters ahead.

7

ROE Should Outperform

Notes: We classify the market cycle based upon the rate of change in a three month moving average of the Conference Board’s Leading Economic Index. We have made some manual adjustments around the mid-90’s EM crisis and 1998 Russian debt crisis, given the market began to ‘look through’ economic weakness much sooner than usual during these time periods. Notably, we have made no adjustments to our framework for the late-90s TMT bubble or around the 2008-2009 Financial Crisis. Sources: Wolfe Research Portfolio Strategy, Standard & Poor’s, Compustat, Thomson Financial, and FactSet.

• ROE factor performance really begins to kick into gear in the Early Deceleration phase of the market cycle.

Buying High

ROE

Companies

Generates

Alpha Over Time

The Factor

Really Starts

Working in

Early

Deceleration!

8

ROE Decomposition

Sources: Wolfe Research Portfolio Strategy, Standard & Poor’s, Compustat, Thomson Financial, and FactSet.

• Looking at component trends for the overall market, it becomes clear that there’s probably the most upside from asset turnover and leverage rebounding from historically low levels rather than additional margin expansion, lower interest expenses, or falling tax rates (outside of a comprehensive tax reform deal).

• High ROEs (top quintile within sector); (2) growing EPS at least 10% in each of the past 3 years; and (3) relatively low sensitivity to historical bouts of emerging markets volatility.

9

Stable Growth Companies

Notes:*SIM = our proprietary Stock Idea Model, filter is 1500 largest US market cap. Companies, top quintile highest ROCE, minimum 20 earnings quality (out of 100), 3 years >10% LTM EPS growth and below average EM volatility sensitivity. Below average EM volatility sensitivity defined as outperforming the S&P 1500 on average during EM volatility spike periods in last 4 years. Sources: Wolfe Research Portfolio Strategy, Standard & Poor’s, Company filings, Bloomberg, and FactSet. Market data as of 2/19/2015.

Ticker Company Sector

Market

Cap. ($ in

millions)

LTM

Total

Return

SIM Score

[1 = best;

5 = worst]

3Q14 EQ

Score ROCE

6 Mo.

Undiv-

ersified

Return

Short

Interest /

Float %

2015E

P/E

LTM FCFF

Yield

Foreign

Sales

SBUX Starbucks Corp. Cons. Disc. 70,337 29% 4 41 45% 9.3% 1.2% 29.8x -1% 23%

ROST Ross Stores Inc. Cons. Disc. 20,138 46% 1 85 36% 45.0% 1.8% 22.5x 3% 0%

ORLY O'Reilly Automotive Inc. Cons. Disc. 21,863 32% 1 95 42% 23.8% 5.6% 23.9x 4% 0%

UA Under Armour, Inc. Cons. Disc. 15,682 40% 5 24 30% 0.2% 7.7% 68.1x 0% 6%

DLTR Dollar Tree, Inc. Cons. Disc. 16,144 49% 2 74 35% 29.3% 6.7% 24.7x 4% 0%

TSCO Tractor Supply Co. Cons. Disc. 11,819 34% 3 48 25% 21.2% 4.1% 28.6x 2% 0%

PETM PetSmart, Inc. Cons. Disc. 8,593 29% 1 78 31% 14.9% 2.5% 18.8x 6% 6%

KR The Kroger Co. Cons. Staples 47,002 87% 3 58 28% 31.9% 1.8% 21.4x 4% 0%

SAM Boston Beer Co. Inc. Cons. Staples 4,005 36% 5 39 38% 45.5% 11.0% 39.1x 0% 0%

TRV The Travelers Companies, Inc. Financials 40,583 31% 1 NA 14% 15.3% 2.5% 11.3x NA 4%

RE Everest Re Group Ltd. Financials 8,690 22% 1 NA 15% 6.9% 4.1% 9.5x NA 44%

JLL Jones Lang LaSalle Inc. Financials 7,387 35% 4 NA 18% 14.0% 1.9% 18.1x NA 56%

WRB W.R. Berkley Corp. Financials 7,696 27% 1 NA 16% 10.2% 3.1% 14.4x NA 0%

OHI Omega Healthcare Investors Inc. Financials 7,768 37% 2 NA 18% 18.7% 10.0% 23.9x NA 0%

PRAA Portfolio Recovery Associates Inc. Financials 4,043 -10% 4 NA 21% 12.5% 25.0% 11.4x NA 1%

AMGN Amgen Inc. Healthcare 122,474 29% 1 82 20% 28.2% 0.9% 16.8x 6% 22%

BIIB Biogen Idec Inc. Healthcare 92,610 21% 2 70 34% 1.3% 1.3% 23.9x 3% 30%

MCK McKesson Corp. Healthcare 60,347 29% 2 70 22% 11.2% 0.6% 20.8x 4% 8%

ALXN Alexion Pharma, Inc. Healthcare 35,510 3% 4 56 24% 7.1% 1.5% 31.4x 1% 58%

ILMN Illumina Inc. Healthcare 29,229 17% 3 73 32% 13.6% 1.5% 63.4x 1% 50%

CAH Cardinal Health, Inc. Healthcare 29,648 23% 1 82 17% 14.1% 1.2% 19.9x 5% 3%

EW Edwards Lifesciences Corp. Healthcare 13,453 96% 1 94 19% 51.0% 0.6% 31.8x 8% 54%

HSIC Henry Schein, Inc. Healthcare 13,100 20% 3 61 16% 17.1% 2.9% 23.9x 4% 39%

PCYC Pharmacyclics Inc. Healthcare 12,387 22% 5 37 24% 22.0% 8.5% 121.8x 1% 0%

PRXL PAREXEL Int'l Corp. Healthcare 3,511 17% 1 91 26% 10.4% 7.2% 23.0x 8% 45%

UNP Union Pacific Corp. Industrials 117,878 40% 3 77 25% 19.7% 0.8% 18.6x 3% 10%

HON Honeywell Int'l Inc. Industrials 81,674 14% 2 51 25% 6.8% 0.7% 17.2x 5% 41%

RHI Robert Half Int'l Inc. Industrials 7,983 54% 3 41 35% 16.9% 2.1% 23.0x 4% 24%

FLT FleetCor Technologies, Inc. Info. Tech. 16,684 30% 4 40 25% 2.1% 1.3% 25.5x 4% 30%

TSS Total System Svcs, Inc. Info. Tech. 8,208 28% 3 40 20% 5.0% 1.7% 17.1x 6% 32%

JKHY Jack Henry & Associates Inc. Info. Tech. 5,440 17% 1 75 21% 6.3% 0.9% 25.2x 6% 0%

MMS MAXIMUS, Inc. Info. Tech. 3,727 25% 4 27 25% 30.6% 1.3% 24.9x 5% 25%

TYL Tyler Technologies, Inc. Info. Tech. 3,731 20% 3 84 24% 14.5% 3.2% 48.6x 3% 0%

GPK Graphic Packaging Holding Co. Materials 7,006 52% 1 76 20% 13.5% 2.0% 20.7x 5% 11%

ITC ITC Holdings Corp. Utilities 10,225 17% 3 45 18% 20.0% 2.6% 19.0x -1% 0%

10

DISCLOSURE SECTION

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