The Canadian Edge Portfolio scored positive total returns in 2012, its fourth consecutive year in the black. Our Holdings returned 6.9 percent on average.

Conservative Holdings contributed 12.2 percent, slightly below 2011’s 13.1 percent. Aggressive Holdings lost an average of 1.7 percent but improved from last year’s negative 7.6 percent.

Meanwhile, our three closed-end mutual fund selections (see In Focus) came in at 10.5 percent.

The first takeaway from the table “Performance” is the wide divergence in return figures among individual recommendations. Starting with the positive, 29 of the picks were in the black versus 12 that lost money during the year.

More than half the recommendations had a double-digit total returns, nearly a third did better than 20 percent and three–Acadian Timber Corp (TSX: ADN, OTC: ACAZF), Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) and TransForce Inc (TSX: TFI, OTC: TFIFF)–bested 50 percent.

On the negative side, half a dozen recommendations lost at least 10 percent.

Our biggest losers were IBI Group Inc (TSX: IBG, OTC: IBIBF) and three energy-related positions for which I swapped companies during the year: Enerplus Corp (TSX: ERF, NYSE: ERF)/Pengrowth Energy Corp (TSX: PGF, NYSE: PGH), Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE)/PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF) and PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)/Poseidon Concepts Corp (TSX: PSN, OTC: POOSF).

The second takeaway is that, as in 2011, 2012 performance was markedly different from what happened in 2010.

That year, even underperforming stocks were in the black or close to it, including now-sold companies such as Perpetual Energy Inc (TSX: PMT, OTC: PMGYF) that actually cut dividends.

Such signs of internal weakness were definitely not tolerated in 2011, and the result was a handful of large losses that dragged down returns. And setbacks were even more toxic in 2012.

The nearly 40 percent loss on the combined Penn West/PetroBakken position, for example, was due purely to worries about oil prices, as neither company actually cut dividends.

Returns in 2010, as in 2009, were of course so robust in large part because they were part and parcel of the recovery from the crash of 2008.

And they also reflected the fact that income trusts’ conversions to corporations went far more smoothly than anyone expected, except perhaps those of us at Canadian Edge.

By early 2011 those bullish tailwinds were ancient history. Instead, Canadian stocks began responding to a still sluggish economic environment and growing political uncertainty in the US, reaching a crescendo of worry with this month’s fiscal cliff battle.

The upshot: Rather than look for reasons to buy stocks, investors have been looking for excuses to sell them.

And what’s evolved is an environment where buying and selling momentum–rather than any discernible measure of value–has dictated prices and returns.

Once they’ve begun to rally favored stocks have continued to surge, as investors have equated a rising price with safety.

Conversely, once a stock has begun to drop the urge to pile on has become irresistible, and prices have continued to plunge.

Most interesting is the way outperformers and underperformers in 2011 swapped places in 2012, even though underlying company business performance was steady.

TransForce, for example, returned just 4.4 percent in 2011, and that was only after digging out of the deep hole it had fallen into over the summer. But it extended those gains into a 60 percent-plus return in 2012. Acadian and Parkland followed the same pattern.

Conversely, EnerCare Inc (TSX: ECI, OTC: CSUWF) actually raised dividends twice in 2012. But the stock went from a nearly 45 percent return in 2011 to a loss last year. Similarly, our Canadian midstream energy trio Altagas Ltd (TSX: ALA, OTC: ATGFF), Keyera Corp (TSX: KEY, OTC: KEYUF) and Pembina Pipeline Corp (TSX: PPL, NYSE: PBA) gained an average of 47 percent in 2011 but barely 7 percent in 2012.

To some extent performance was influenced by stock sector. As the graph “Performance by Sector” shows, Oil and Gas and Energy Services were both weak in 2012. Producers’ returns were even worse after taking out takeover related gains of 70 percent-plus for Nexen Inc (TSX: NXY, NYSE: NXY) and the former Progress Energy Resources Corp.

Not surprisingly, both sectors’ returns were hit hard by early 2012 weakness in prices of natural gas and natural gas liquids (NGL) and later by worries about oil prices. The latter’s impact on Canadian producers and drillers was made worse by a sharp increase in Canada-US pricing differentials due to the inability to get surging northern volumes to markets southward.

As a result only a handful of oil and gas producers and energy services companies posted solidly positive total returns for 2012. Our best were Newalta Corp (TSX: NAL, OTC: NWLTF) and Vermilion Energy Inc (TSX: VET, OTC: VEMTF). ARC Resources Ltd (TSX: ARX, OTC: AETUF) and Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) were also in the black, barely, while Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF) was slightly underwater.

By contrast, every single Canadian real estate investment trust (REIT) tracked in How They Rate was a winner in 2012. Our five REITs–Artis REIT (TSX: AX-U, OTC: ARESF), Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), Dundee REIT (TSX: D-U, OTC: DRTEF), Northern Property REIT (TSX: NPR-U, OTC: NPRUF) and RioCan REIT (TSX: REI-U, OTC: RIOCF)–added an average total return of roughly 17 percent to their gains of the past few years.

This solid performance was also no surprise. Canadian REITs were among the few sectors in North America to weather the 2008 crisis with their fortunes intact, thanks mainly to very conservative operating and financial policies.

They continue to take advantage of their relative strength and low interest rates to expand.

And despite four years of solid returns, they’re still cheaper on a valuation basis than US REITs, particularly with several–such as CAP REIT and RioCan–returning to dividend growth in 2012.

Most sectors, however, featured quite a bit of performance divergence.

As a result the year’s best returns flowed from picking the stocks that enjoyed buying momentum and avoiding those that suffered from selling momentum.

Lessons of the Fall

Our focus at Canadian Edge is building long-term returns as companies’ underlying businesses grow, not maximizing short-term returns through market timing.

But there are definite lessons to be learned from the action in 2012 that can improve our returns in 2013.

First, putting up a positive number is no mean feat in a year so volatile and uncertain. And Canadian Edge did exactly that, with an average total return of 6.9 percent on the 41 overall holdings for calendar year 2012.

Second, as was the case in 2011, we definitely got caught with our proverbial drawers down in several stocks. The position that started the year as PHX Energy Services and swapped into Poseidon Concepts, for example, wound up under water by more than 90 percent.

Exiting long-held positions in Enerplus and Penn West this spring was the right thing to do, as we avoided deep losses in both stocks and a 50 percent dividend cut in the former.

Moving immediately into sector alternatives, however, most definitely blew up in my face. The results were a big realized loss in Pengrowth Energy that I took in the December issue and a large paper loss in PetroBakken, still an Aggressive Holding.

With 20-20 hindsight CE Portfolio performance would have been much improved had I not held positions in these stocks. And the same is true for IBI Group, which, like Pengrowth and Poseidon, cut its dividend during the year and saw its stock suffer greatly for the transgression.

Without those four positions the Aggressive Holdings would have been well in the black, while Conservative Holdings would have handily beaten 2011’s gains.

In fact, just not making the swap from PHX to Poseidon in October would have pushed the Aggressive Holdings well into the black and the average Portfolio pick’s return well past 10 percent.

If you’re making money it makes no sense to abandon your overall strategy.

And losses in individual positions aside, we’ve done that consistently in Canadian Edge in a volatile and uncertain environment by buying and holding quality companies, so long as their underlying businesses remain able to grow and build wealth over time.

It’s always constructive, however, to examine why you make moves that lose money, for the purposes of avoiding similar mistakes. And the irony is three of my four most damaging moves in 2012 came as a result of trying to reduce risk.

I sold Enerplus and Penn West last year because they appeared to be at risk to a weakening energy price environment.

In Enerplus’ case my concern was the company couldn’t afford to increase oil production and maintain its dividend with the price of natural gas falling as it did in first half 2012. That proved to be the case, as the company cut its dividend in half. In fact, as I note in Dividend Watch List, debt is still rising at a worrisome rate.

By contrast, at the time Pengrowth’s rising oil production, relatively lower reliance on natural gas and untapped credit lines seemed to make it a solid bet to weather an environment of weak gas prices. But oil prices began to drop, and the company was also forced to cut its dividend, resulting in a selloff that was nearly identical to what we would have suffered simply by holding onto Enerplus.

Falling oil prices were also to blame for the paper loss we have in PetroBakken. The stock has outperformed Penn West shares. But the best move would clearly have been to simply sell Penn West, sit back and wait for energy prices to firm.

The Canadian Edge Portfolio is based on maintaining broad diversification among sectors. And action in energy prices such as we saw this year is comparatively rare. Consequently, I’m still convinced making a swap was the right move. Rather, the error was not making the exchange to a sector stock where there was a much more clear difference in quality/safety.

In the case of both Pengrowth and PetroBakken, the companies were demonstrably safer than the stocks they replaced–but only so long as the pricing environment for oil was solid. Swapping for them was also a bet that oil would continue to hold up where gas had not.

Safety was in short supply in the oil and gas production industry last year, to be sure.

But a position in lower-yielding/much lower payout ratio-bearing Cenovus Energy Inc (TSX: CVE, NYSE: CVE) would have yielded a positive total return with dividend growth.

Moving to the PHX-for-Poseidon swap, my mistake was of a much different nature.

First, I cut Poseidon’s management far too much slack because its predecessor company Open Range Energy Corp had recently worked a deal to sell oil and gas production assets to Portfolio favorite Peyto Exploration in August.

Since the aftermath of Hurricane Katrina in 2005 natural gas prices in North America have basically been in a downtrend.

Over that time many companies have been driven to ruin. But by running its business better than anyone else Peyto has thrived.

In buying Poseidon I reasoned the predecessor company’s management–and by extension Poseidon’s–was quite solid and prepared to face the challenges of a volatile industry. I also concluded Poseidon’s hydraulic fracturing fluid management business had a ready-made base of customers, since the company had been in the production business.

Finally, I gave weight to the company’s statements and reported numbers, which indicated fluid tank rentals were indeed a renewal-based business that didn’t depend so much on new drilling as PHX’ rigs did.

As I’ve pointed out many times in CE, my system relies heavily on business numbers to pick companies. The converse of that is I don’t sell until those numbers clearly show there’s weakness at the underlying company. I always want to know why a stock I like has fallen. But I’m not going to react on the basis of a stock’s move alone.

The value of that kind of focus is proven by the fact that so many underperformers in the CE Portfolio one year have been big winners the next.

Contrary to popular opinion, the market is not always right. Rather, it’s a popularity contest in the short term and a weighing machine in the long run. If you want the big returns, you’ve got to stick around long enough for your stocks to be properly weighed–not get bluffed out by the mood swings of others who probably have worse information than you do.

Equally, however, I did miss what was going on with Poseidon until the horse was well out of the barn–and in fact across the field and deep into the woods. But my mistake was not in trusting the numbers.

Rather, it was not giving enough weight to the fact that this was a new company that had only begun paying a dividend in December 2011. More to the point, there was no precedent for a company renting water tanks to energy companies and sustaining a high payout over any meaningful length of time.

When David Dittman and I started Canadian Edge back in 2004, I vowed not to even pick up coverage of any income trust that didn’t follow a business model with proven long-term dividend-paying ability. That didn’t prevent me from making losing Portfolio recommendations. But it did save readers from considering trusts that did turn out to be quasi-Ponzi schemes.

That’s not my opinion of Poseidon, by the way. But no matter how well you study individual companies’ books or even question their executives, you’re not going to have perfect information. And by recommending Poseidon as an Aggressive Holding soon after picking it up for coverage–despite the fact that it was a new company without a proven dividend paying business model–I violated a rule I had followed for many years.

That’s a move I will do my utmost not to repeat in 2013, even as another group of Canadian companies moves to a dividend-paying model.

If a company is following an untested model for paying dividends I’ll let someone else test ride it first.

As for IBI Group, the loss taken in 2012 is a direct consequence of my investment style, i.e. sticking with companies that are consistently building their business even when they encounter headwinds.

The damage to the stock was basically all within a three-day period in early November, following the release of less-than-stellar third-quarter results.

The stock has been flat since the company cut its dividend 50 percent last month.

As I write in Dividend Watch List, I’m not ready to recommend this stock as a buy again. But I do plan to hold so long as management continues to build its global business. And I expect to see the stock trade in double-digits in the next couple of years, sooner if overall economic conditions improve.

From the standpoint of CE’s 2012 return, it absolutely would have been better not to hold the stock in 2012. But IBI is still the kind of stock that will build wealth for us over the long term if we’re patient. And I’m willing to keep betting on that despite the paper loss, at least until management proves me wrong and stops growing the company. IBI Group is a hold.

What to Do With Winners

Many if not most investors generally pay far more attention to losers than winners. That much is clear from the kind of viewer mail I get.

But how you deal with your stocks that have gone up is actually even more important to future returns than how you deal with losers.

When a stock loses value it becomes a less important part of your portfolio. But for every percentage point a stock’s price increases the bigger the portion of your wealth it becomes–and the greater the bite that would come out of your hide should it suddenly give way.

I’ve tried to help Canadian Edge readers control this risk in two ways.

First, I never, ever recommend anyone over-weight their portfolio to a particular stock or sector when they buy. And I never recommend anyone pay more than the target buy prices I list for each company, which are based on a combination of prospective return, or dividends plus growth, and risk, as measured by the CE Safety Rating System.

Second, I’ve periodically recommended investors take profits in individual CE recommendations that have risen sharply. This strategy has already proven its worth several times in the past year.

For example, investors had an opportunity to pare back holdings of Keyera Corp when the stock hit highs of better than USD50 in early 2012 and then to buy it back under USD40 in late spring for a ride back to USD50 by the end of the year.

Taking partial profits is a strategy that will work so long as investors are still following buying and selling momentum as signals for getting in and out of stocks. And based on a look at the Portfolio there are several candidates now for some gentle profit-taking.

The key isn’t to take every profit that comes your way. Most of the time it’s best to just sit back and let your holdings keep paying their dividends and growing their businesses.

It is vital, however, to maintain your portfolio’s balance and diversification by periodically dialing back stocks that are have come to be over-weighted and deploying the funds elsewhere.

As for the past year’s biggest winners, I’m sticking with all of them for the time being and fully expect to see them at much higher prices down the road.

That includes Acadian, Parkland and TransForce, though none of the trio is likely to repeat their stellar 2012 performance in 2013.

This month I’ve changed Parkland from a hold to a buy up to USD18.

That’s still a bit below the current price. But it’s a number I’m now very comfortable with in the wake of the company’s purchase of the energy marketing assets of battered AvenEx Energy Corp (TSX: AVF, OTC: AVNDF). These assets include expertise in rail-based energy transport and will add CAD0.16 per share in distributable cash flow this year.

Parkland still faces a challenge replacing supply contracts in coming years for its fuel marketing business. And we’ve yet to see a dividend increase despite the recent quantum leap in profitability. But 2012’s top turnaround story still looks like it has plenty in the tank despite its much higher share price.

Readers will also note that I’ve raised buy targets on several other recommendations (see the Portfolio tables for up-to-date advice) and upgraded two other companies from hold to buy.

One is Peyto, which has been a big winner in recent years though it finished even for 2012; the low-cost gas producer is a buy up to USD22.

The other is Extendicare Inc (TSX: EXE, OTC: EXETF). This resilient company continues to battle the headwinds of Medicare cuts by improving efficiency, reducing operating/legal risk and slashing debt cuts. With a dividend cut already priced in–though still unlikely–Extendicare is a buy up to USD8.

Extendicare was barely a winner last year, as its hefty payout offset a slight dip in the share price. But any improvement in the company’s operating environment–including anything that clarifies future Medicare spending and regulations–could turn it into a big winner in 2012.

The stock carries risks, and for that it’s an Aggressive Holding. But the yield of nearly 11 percent means there’s more than sufficient upside potential for risk tolerant investors to own it.

That also goes for Just Energy Group Inc (TSX: JE, NYSE: JE), which I dropped down to the Aggressive Holdings last month. The company faces greater risks over the next 12 months than it has to date, as it expands its business by acquiring customers that require greater up front expenses for a richer payoff later on.

The company’s receipt of a CAD105 million cash infusion from the Canada Pension Plan Investment Board spooked some investors last month because of its apparently high price tag–a 9.75 percent annual interest rate on unsecured five-and-a-half year notes. Although that’s certainly well above what investment-grade debt is paying, the important thing is the terms are still accretive for this company.

So long as that’s the case management will be able to grow the business and fund generous distributions. The payout ratio as a percentage of funds from operations is likely to remain high the next couple years as the company grows its business, and the board will review the current dividend in that light in May.

At a current yield of above 12 percent, however, it’s hard to argue a reduction isn’t already priced in, which management to date has asserted isn’t necessary. Just Energy remains a buy up to USD16 for those who don’t already own it.

The Next Numbers

Here’s when the next round of numbers for Canadian Edge Portfolio Holdings is currently expected. I’ve indicated companies that have announced actual release dates as “confirmed” and the rest as “estimates.”

As this list shows, many of the companies aren’t slated to announce numbers until after the next issue of CE is published on Feb. 8, 2013. And some may not actually report until the March issue is published. This means readers can expect to see a lot of Flash Alerts in coming weeks to bring them up to date on our companies.

The primary reason for the longer reporting period is most of these companies are announcing full-year 2012 results as well as fourth-quarter numbers. Oil and gas producers are also required to file estimates of their reserves along with financials.

As is the case in the US, companies need more time to get the information together. The resulting delay makes the news and numbers less timely when they do finally come out. But these reports and their accompanying conference calls are still the most important source for seeing how well these underlying businesses are holding up in a challenging environment–and I’ll be paying close attention.

Conservative Holdings

• AltaGas Ltd (TSX: ALA, OTC: ATGFF)–March 8 (estimate)
• Artis REIT (TSX: AX-U, OTC: ARESF)–Feb. 28 (confirmed)
• Atlantic Power Corp (TSX: ATP, NYSE: AT)–Feb. 28 (estimate)
• Bird Construction Inc (TSX: BDT, OTC: BIRDF)–March 7 (estimate)
• Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)–March 12 (estimate)
• Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF)–Feb. 13 (estimate)
• Canadian Apartment Properties REIT (TSX: CAR, OTC: CDPYF)–Feb. 28 (estimate)
• Cineplex Inc (TSX: CGX, OTC: CPXGF)–Feb. 28 (estimate)
• Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)–March 6 (estimate)
• Dundee REIT (TSX: D-U, OTC: DRETF)–Feb. 22 (estimate)
• EnerCare Inc (TSX: ECI, OTC: CSUWF)–Feb. 22 (estimate)
• Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–March 21 (estimate)
• Keyera Corp (TSX: KEY, OTC: KEYUF)–Feb. 15 (estimate)
• Northern Property REIT (TSX: NPR, OTC: NPRUF)–March 13 (estimate)
• Pembina Pipeline Corp (TSX: PPL, NYSE: PBA)–Feb. 15 (estimate)
• RioCan REIT (TSX: REI, OTC: RIOCF)–Feb. 14 (estimate)
• Shaw Communications Inc (TSX: SJR/A. NYSE: SJR)–Jan. 9 (confirmed)
• Student Transportation Inc (TSX: STB, NSDQ: STB)–Feb. 13 (estimate)
• TransForce Inc (TSX: TFI, OTC: TFIFF)–Feb. 28 (estimate)

Aggressive Holdings

• Acadian Timber Corp (TSX: ADN OTC: ACAZF)–Feb. 6 (estimate)
• Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–March 14 (estimate)
• ARC Resources Ltd (TSX: ARX, OTC: AETUF)–Feb. 8 (estimate)
• Chemtrade Logistics Income Fund (TSX: CHE, OTC: CGIFF)–Feb. 22 (estimate)
• Colabor Group Inc (TSX: GCL, OTC: COLFF)–March 22 (estimate)
• Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–March 15 (estimate)
• Extendicare Inc (TSX: EXE, OTC: EXETF)–March 1 (estimate)
• IBI Group Inc (TSX: IBG, OTC: IBIBF)–March 26 (estimate)
• Just Energy Group Inc (TSX: JE, NYSE: JE)–Feb. 8 (estimate)
• Newalta Corp (TSX: NAL, OTC: NWLTF)–Feb. 15 (estimate)
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–Feb. 14 (estimate)
• Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–March 7 (estimate)
• PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–March 7 (estimate)
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–March 7 (estimate)
• Vermilion Energy Inc (TSX: VET, OTC: VEMTF)–March 5 (estimate)
• Wajax Corp (TSX: WJX, OTC: WJXFF)–March 6 (estimate)