A Tale of Two Canadas

12/21/2011 9:30 am EST

Focus: GLOBAL

Roger Conrad

Founder and Chief Editor, Capitalist Times

By being selective and strategically diversified, you can absorb some hard individual losses and still post strong numbers, which is key to successful long-term income investing, writes Roger Conrad of Canadian Edge.

The broad-based MSCI Canada Index is down 10.4% year to date in US dollar terms, including dividends. Meanwhile, the Canadian Edge Conservative Holdings are in the black by 9.4 percent, and the Aggressive Holdings are down 4.1%, including positions closed out this year.

Those figures, however, mask a huge divergence in performance of individual stocks. In fact, price has emerged as a major problem for would-be buyers of these stocks—including AltaGas (Toronto: ALA), Keyera (Toronto: KEY), and Pembina Pipeline (Toronto: PPL).

Fearful investors have bid them up as safe havens in a rough market, and all three now sell above my buy targets.

In the other Canada, we’ve had three true blow-ups in 2011—i.e. losses of at least 50%. The last of these is Capstone Infrastructure (Toronto: CSE), whose dividend cut warning I highlighted in a December 6 alert. All three of these are now out of the Portfolio.

Other stocks, however, have fared poorly this year despite solid underlying business performance. That includes several that increased dividends, such as Davis + Henderson Income (Toronto: DH). Its shares are down 25% this year, despite consistent double-digit cash flow growth and a 3.3% dividend boost.

Atlantic Power (AT) shares have dropped nearly 15% since June 20, when the company announced its now-completed acquisition of the former Capital Power LP. That’s despite a relatively smooth merger process, now locked in financing, and a 4.6% dividend increase effective with the December 30 payment.

Just Energy Group (Toronto: JE), meanwhile, has lost a third of its value since June 30, despite continuing to report solid results and repeatedly affirming the safety of its dividend.

Welcome to the two Canadas. Just as in the US, dividend-paying stocks deemed “safe” by investors are being bid to new heights. Meanwhile, stocks perceived risky are cast aside and driven down to new lows, recovering only when they prove their strength to enough buyers.

Despite the extreme market volatility and worries about the Eurozone crisis, several stocks have staged massive recoveries from the year’s lows. Bird Construction (Toronto: BDT), for example, is up 40% from early autumn lows, as the acquisition of O’Connell has pushed up orders and earnings. Parkland Fuel (Toronto: PKI) is up 65% from early October, a point where some investors assumed its price drop meant a dividend cut was imminent.

Provident Energy (PVX) was given up for dead by many in late summer before rallying 40%-plus. So was EnerCare (Toronto: ECI), now trading at an all-time high after surging more than 40% off its low. So was Newalta (Toronto: NAL), now also 40% up from its low. Even Colabor Group (Toronto: GCL) has been able to regain a double-digit share price after what some assumed was a death dive earlier this year.

All of these companies were still performing well as businesses when their stocks were touching bottom this year. What changed was investors’ perception of their dividend risk shrank markedly.

Looking back, it’s difficult to pinpoint a catalyst that turned a downtrend into an uptrend. But it is clear that the more these stocks recovered, the more buying picked up, and the higher share prices went. It’s literally the mirror image of what fueled the selling on the way down. Mainly, lower share prices undermined investors’ resolve and more sold, driving down prices further still.

All of these stocks hit their nadir right around the time Yellow Media (Toronto: YLO) collapsed. Fear of getting caught with another Yellow induced many investors to unload anything that smelled of risk. As a result, they sold good stocks low, only to watch them recover in a matter of weeks.

To be sure, some companies that sell off do eventually crack. I was caught by Capstone, as were most other analysts given the 33% drop the day of the guidance announcement. And unfortunately, we’re likely to see more such blowups as long as the North American economy is growing slowly and Europe is a threat to global credit markets.

Fortunately, the only way such a position can really hurt you is by investing more all the way down. And I can’t advise more strongly against such an inherently emotional and self-destructive strategy.

Diversification and portfolio balance—much more than wise selection or luck—literally saved me from mistakes and bad luck, while allowing me to stay in well-run, dividend-paying companies despite what’s still one of the toughest markets in memory.

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