What do you get when an increasingly volatile market enters earnings reporting season after stocks have rallied strongly for two years? Pretty much what we’ve seen the past couple weeks.

Higher stock prices mean rising investor expectations that are increasingly hard to beat, if not match. Of the handful of Canadian Edge Portfolio Holdings reporting first-quarter 2011 earnings thus far, most have measured up on that score. That, however, hasn’t stopped investors from selling them off in the wake of worries about the world economy and oil prices. And corresponding erosion in the value of the Canadian dollar has added to the damage for US investors.

Meanwhile, one of my holdings–Colabor Group Inc (TSX: GCL, OTC: COLFF)–encountered some unexpected turbulence from a combination of weak restaurant traffic and spiking fuel costs. Its earnings came in below expectations and its stock was hit with a sharp selloff this week. The first-day drop was because of the numbers and the second was due to downgrades from a buy to a hold by three of the five analysts covering the stock.

For the past several months I’ve urged investors to take money off the table in their biggest winners, particularly in any stock that’s become a disproportionately large piece of their overall portfolio. I’ve also warned against “doubling down” or loading up on stocks that suddenly lose ground as well as paying more for hot stocks that have surged above buy targets.

If you’ve been following this advice, you should be in pretty good shape in this selloff. To that, I would once again warn against the use of hard stop-losses in these stocks, particularly of the trailing variety.

Too often you’ll find yourself washed out at a much lower price by a wave of sell orders generated by fellow stop-loss users. And I would generally avoid use of leverage as well. There’s plenty of upside without it, and there’s nothing like rising volatility to wipe out leveraged positions.

Whether or not the past week’s downside in Canadian stocks picks up steam or falters will probably come down to perceptions about where the global economy is headed. As CE readers know, there’s a lot more to the Northern Tiger than oil prices.

But that, in effect, is how many investors–including much of the big money that creates near-term ups and downs–views the country and its currency. And if oil prices should come back under USD100 a barrel even temporarily, we can expect more selling and lower stock prices even for companies that do meet or beat expectations with first-quarter numbers.

Those earnings numbers, however, are precisely where we need to keep focusing. Over the near term myriad factors will affect share prices. But as income investors we need to remember that we’re generally not in this for short-term trading. Rather, we’re going to make our returns from collecting a rising stream of dividends–and the share price appreciation that inevitably flows from that.

We don’t want to hang around in a stock where there’s genuine business weakness that can sink us. But as long as companies are still positioned to maintain dividends and management is sticking to guidance, we’re going to be riding out this selloff. In fact, most likely we’re going to be using this selloff to pick up good stocks at low prices.

The key, then, is whether underlying businesses are still healthy and growing, thereby safeguarding dividends and building wealth. And the best way to answer that question now is a close examination of first-quarter earnings, which are just now starting to come in.

Here again is the Canadian Edge portfolio management strategy for this period of generally benign to improving economics, combined with high investor expectations and what appears to be growing market volatility.

• Stick with positions in companies that have healthy and growing businesses, i.e. cover current dividend rates comfortably and are sticking to guidance for future investment and growth.
• Sell any company that appears to falter, such as when an unexpected event seems to undermine its case for dividend safety and growth.
• When investing in Canada, generally avoid use of leverage in all its forms. That means margining positions, overloading into a particular stock, doubling down on a falling stock and unless you’re very, very careful and experienced the use of options.
• Avoid so-called risk avoidance techniques like stop-losses. We always want to know why a stock drops. But as we’ve seen in recent weeks, steep declines are often reversed just as suddenly.
• Don’t pay more than listed buy targets for any company. I’ve set these at prices that should lock in average annual total returns of 10 percent plus, more for companies with lower CE safety ratings. Paying more will lock in subpar returns. And again as we’ve seen repeatedly, steep rises in stocks are often reversed, giving investors another chance to buy.
• Do set dream prices for great stocks that you really want to own. Getting executed 20 percent below the current prices will boost your yield by 25 percent.

Trouble Spots

Those are my rules. Now let’s see how they apply to the current market and Canadian Edge Portfolio Holdings in light of current developments, particularly the release of first-quarter earnings.

As I noted last month, my expectation has been the natural resource bull market, Canada’s generally solid expansion and what appears to be a building recovery in the US would produce generally strong first quarter earnings for CE Portfolio companies. I’ve also voiced the opinion that the rest of the year was shaping up bullishly as well.

Rather, the primary risk to stocks this year is investors’ high expectations, the natural outgrowth of two years of robust market returns. Companies can post numbers that are very strong and still see their stocks drop, as investors either “buy on rumor, sell on news” or find something to be disappointed about.

As of press time, five recommended companies have reported first-quarter 2011 earnings. Four turned in quite robust numbers, including Acadian Timber Corp (TSX: ADN, OTC: ACAZF), AltaGas Ltd (TSX: ALA, OTC: ATGFF), Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) and Yellow Media (TSX: YLO, OTC: YLWPF).

The fifth, Colabor Group, definitely contained disappointing and unexpected developments.

The first four have subsequently performed generally well in the market place, despite the overall market volatility. Colabor, meanwhile, took a two-day plunge starting Wednesday from the neighborhood of USD13 to a low of USD10.70 before bouncing back over USD11on Friday. Day one was a reaction to the news itself. Day two was a reaction to the decision of two analysts who had rated the stock a buy to cut it to hold. Two other firms maintained their ratings, including Desjardins Securities, which kept its buy on the stock.

The question, of course, is whether the news is so bad that investors should get out of Colabor. That the company had an earnings shortfall during the quarter is not in question. Consolidated sales were up 6.2 percent over the year-earlier period, reflecting the successful acquisitions of RTD Distribution on Sept. 21, 2010, and Les Pecheries Norref Quebec on Feb. 28, 2011. The latter was only on the books for roughly a month and so will contribute more robustly to subsequent results.

The revenue growth demonstrates that Colabor is still following through on its long-term strategy of consolidating Canada’s still fragmented food services market. And it shows the company has finally overcome the impact of losing a major customer last year at a then newly acquired Ontario operation.

As management pointed out in its first-quarter conference call, the company’s balance sheet remains very strong, with more than half of its CAD150 million bank credit facility still undrawn and available for making more acquisitions.

One of these is its offer to purchase SKOR Food Group, a wholesale food supplier to the Ontario foodservices and retail industries with annual sales of nearly CAD140 million.

That deal will add immediately to cash flow while boosting opportunities for savings and synergies through greater scale in the province. The company will also begin reaping cash flow this quarter from its purchase of New Brunswick distributor Edfrex.

That being said, Colabor is noticeably experiencing margin pressure in the current market. There were several extraordinary factors this contributed to the CAD2 million drop in cash flow margin. One was a 30 percent spike in fuel costs that shaved about CAD300,000 from profit. Another was simply a drop in restaurant traffic, due in large part to extreme weather conditions. This depressed sales and forced the company to eat costs in order to keep its customers.

That Colabor was able to hold market share even as it kept gaining scale is a testament to the patience and persistence of management. So are the assurances given during the conference call that liquidity and cash flow were still strong and that the dividend is secure. And certainly management has shown it will not overreact to one quarter’s results, having stuck to the dividend in previous quarters where results didn’t measure up.

That the dividend’s safety didn’t come up during the question-and-answer session of the conference call is also reassuring. In fact, one of the analysts cutting to hold actually stated the dividend is supported by cash flow, though they raised their estimated full-year payout ratio to 90 percent versus a previous 75 percent. Rather, their beef seemed to be that growth was coming slower than previously sought.

However encouraging this may be, the fact remains that first-quarter cash flow per share came in at CAD0.13 per share, down from CAD0.27 per share. First-quarter cash flow is typically weaker than other quarters owing to seasonal factors. But that figure is nonetheless only about half the quarterly dividend.

A dividend cut is still highly unlikely this year. But we’re going to have to see improvement in subsequent quarters for it to be sustained over the longer term.

My second concern is that the company couldn’t pass through costs during the quarter that it’s been routinely able to in the past. Again, that was due to extreme conditions, and the larger Colabor becomes the less vulnerable it will be to this dynamic. But the fact remains that the company is exposed now, and this will be a key factor to watch in coming quarters, particularly with the problem of high fuel costs not likely to go away anytime soon.

At this point, the betting is that, one, the dividend will hold and, two, margins will improve in 2012, in part to better operating conditions but mainly because of the company’s growing strength in its industry, where it competes with larges as well as small players. Chief Financial Officer Michel Loignon, for example, stated during the conference call that the company already has “some agreement that we can put some (fuel) surcharge to our client.”

Consequently, I continue to recommend anyone with a position in Colabor Group stick with it. However, until the numbers improve, I’m cutting it down to a hold.

I am, however, recommending one sell in the Portfolio at the time: CML Healthcare Inc (TSX: CLC, OTC: CMHIF). I’ve been wary of this one for some months but up-rated it to a buy below USD12 last month, after the company reported what were generally solid fourth-quarter and full-year 2010 results. Cash flows again covered the dividend that quarter, and it seemed management was finally getting the troubles at the US division under control.

Then came the announcement on May 3 that the company’s Chief Executive Officer Paul Bristow and Chief Operating Office Kent Nicholson had left the company “to pursue other interests and opportunities.” In their place stepped Patrice E. Merrin, Chairman of the Board of Directors and a director/trustee since March 2008, but never and operating executive for CML.

Directors leave companies all the time for all kinds of reasons that have nothing to do with the health of underlying businesses. In fact, I was saddened this week to learn of the pending departure of the Chief Financial Officer of Conservative Holding Atlantic Power Corp (TSX: ATP, NYSE: AT), Patrick Welch.

Mr. Welch, however, is sticking around until a replacement is found, even providing support in the preparation and filing of reports for the quarter ending Jun. 30.

In contrast, there’s no timetable for replacing Mr. Bristow and Mr. Nicholson at CML, both of whom have presumably already packed their bags and moved on.

Not even that would be particularly disturbing were it not for the fact that CML continues to face steep challenges in the US. Now the company will have to deal with that without the efforts of the two men who engineered the strategy.

That suggests harsh measures are likely in order at the company, with the first installment likely at the May 19 first-quarter earnings announcement.

As I’ve written time and again, I want to let the numbers be my guide in making buy/hold/sell decisions. In this case, however, there’s just too much uncertainty about what the next set of numbers are going to be for CML, particularly given how erratic results have been in recent quarters.

Moreover, this shakeup means at the very least a dramatic change in strategy for this company. That may not necessarily be bad. But whatever happens, CML will be a different company from the one I initially recommended in December 2008. I may like what I see, but I may not. And until these issues are decided and the worst is known, I don’t want to own this stock. Sell CML Healthcare.

Solid Returns

As for the other reporting companies, the news was generally good. That also applies to three other recommendations that haven’t yet released actual first-quarter numbers but have reported positive developments.

The company that’s generated by far the most noise from readers in recent weeks is Yellow Media. That’s no doubt because of the steady decline in the share price since last month, when an analyst began coverage of the company with a sell, based on their view that the Internet business growth couldn’t possibly keep pace with the decline of the print directory business.

I also suspect another reason: Too many readers haven’t followed my admonition never to overload on a single stock, and have instead been effectively doubling down on their position every time Yellow has dipped.

To be sure, Yellow has had plenty of ups and downs since entering what’s effectively been a trading range between USD4 and USD6 since early 2009. And I’ve had conversations with some investors who’ve been able to make good money buying when the stock has hit the low end and selling when it’s hit the high end. Hats off to anyone who’s done this successfully and I take absolutely no credit, as this is not a strategy I’ve ever advocated.

On the other hand, Yellow is just one stock of many choices, and it should be treated that way. No one should ever weight their portfolio to it or any other single security, no matter how attractive its now 14 percent-plus yield looks.

That being said, I found a lot to like in Yellow’s first-quarter numbers. The biggest was the payout ratio 70 percent based on adjusted earnings from continuing operations per common share of CAD0.23.

These were lower than last year’s CAD0.27 share. The primary reason, however, is that operations included in the sale of Trader have now been reclassified as “discontinued.”

Meanwhile, the company’s overall revenue from its current operations rose 2.9 percent, fueled by a 39 percent jump in online revenue. The web now represents more than 25 percent of total sales, up from 18 percent a year ago. Moreover, 30 percent of YellowPages.ca traffic currently comes from wireless devices. All that’s pretty clear confirmation that Yellow’s online business is not only expanding without the Trader operation, but that it’s still growing faster than the print division is contracting.

As I’ve written here numerous times, Yellow’s key challenge is convincing enough of its traditional customers to adopt Internet advertising, after simply writing an annual check for a print ad year after year. The jury’s still out on their long-term ability to succeed. But for another quarter at least, they are definitely succeeding.

Meanwhile, the Trader sale–while throwing headline earnings under Generally Accepted Accounting Principles to a loss in the first quarter–has generated CAD745 million in cash, CAD500 million of which will be used to cut debt. The company still has that operation’s real estate and employment outlets, which it intends to grow as it did the automotive business so successfully.

In the first-quarter conference call management stated it expects the payout ratio to be reduced in future quarters, as the impact of reinvestment and divestiture of Trader is fully reflected. The company is also using free cash flow to buy back up to 10 percent of units and both Dominion Bond Rating Service and S&P have affirmed credit ratings recently.

All this augurs good things ahead for the company, though it seems to have done little to sway the overwhelmingly negative investor consensus. That’s fine as far as I’m concerned. As long as Yellow continues to succeed, it’s only a matter of time before its stock rebounds swiftly.

On the other hand, this is a company with a print business that is in decline. That may slow as the economy improves and management has noted it is retaining customers, either by converting them to the web or keeping them in print pages. But until the web becomes the lion’s share of business, print declines will be a threat to watch.

The bottom line is I’m sticking with Yellow. But I’m no longer recommending new positions. Let’s see how things play out as 2001 unfolds. Hold Yellow Media.

Turning to the other reporters, Acadian Timber boosted its first-quarter cash flow margin to 33 percent, up from 28 percent a year earlier. That combined with a 6.2 percent jump in volume sales to produce CAD0.42 per share in free cash flow, up from CAD0.30 a year ago, and to push the payout ratio down to just 50 percent.

Those numbers alone support management’s decision to triple dividends over the past year, and they portend more growth ahead. The global market for softwood products in particular (demand up 17 percent) is extremely robust, and most customers are trying to replenish supplies of hardwood pulpwood as well.

Even the US market has seen a revival, much as management forecast in its fourth-quarter and full-year 2010 conference call.

The company has also greatly improved its financial position by taking advantage of low interest rates to lock in low-cost money and virtually eliminate near-term refinancing risk. That provides priceless flexibility to control volumes to adapt to changing market conditions down the road, which further shores up the dividend.

If you bought Arcadian Timber Corp when I first added it to the Portfolio in early March, stick with your position. If you haven’t gotten it yet, it’s a buy up to my target of USD13. Note this is an Aggressive Holding, meaning there is exposure to commodity price swings. But that should be a plus going forward.

AltaGas Ltd posted first-quarter cash flow per share of CAD0.98, up 29 percent from last year’s tally. Funds from operations–the account from which dividends are paid–surged to CAD0.77, up from CAD0.63 last year. That took the payout ratio down to 43 percent.

Those numbers are certainly good enough to warrant management to consider a dividend increase. At this point, it’s not saying and that in my view means no one should pay more than USD24 for new positions.

But this is definitely the picture of a company in the pink of health. The energy infrastructure operations are seeing growing volumes, as well as reaping the benefits of a strong array of new projects. Recent additions include expansion of field gathering facilities, the purchase of another 40 percent interest in a processing facility and a cogeneration-fired power plant.

The company is also building out hydroelectric power plants via a concession granted in British Columbia, with a 60-year sales contract that’s adjusted for changes in inflation. And it’s pursuing related projects in adjacent areas to utilize its project scale in the region.

All around, it’s steady as she goes for AltaGas, which should have no problem finding more “tuck in” projects near existing assets that provide additional cash flow at little risk, with an expected capital budget of CAD425 million in 2011. Exposure to commodity price swings remains light, thanks to natural hedges in the operations themselves as well as financial ones.

Only 13 percent of extraction volumes from the natural gas liquids operation are exposed to such price swings in 2011, and the company has hedged half of expected 2012 volumes as well.

Meanwhile, the rest of the operation–which is the lion’s share of earnings–is fee-based and largely impervious to even the ups and downs of the energy patch, as the company proved in 2008-09.

Sooner or later we’ll get a dividend increase that will justify paying more for AltaGas. For now, however, investors can enjoy the company’s reliable growth and new buyers can wait on a dip to USD24.

Last but not least, Penn West Petroleum’s solid first quarter is a good sign for both its future prospects and those of the other first-rate energy producers in the CE Aggressive Holdings.

The company’s focus remain on developing light oil resources from the unmatched inventory of resource plays it acquired during its buying spree as an income trust. The company now counts a drilling inventory of more than 10,000 wells, as well as booked reserves conservatively worth at least USD25 per share.

Oil and liquids were 63 percent of total production in the first quarter, a ratio that continues to grow rapidly given the company’s focus. That was despite the outage of a major pipeline that cut Penn West’s output by 10,000 barrels of oil equivalent per day (boe/d), an impact reduced to 3,500 boe/d by extensive marketing efforts company wide to compensate. Light oil output was up 14 percent for the quarter versus year-earlier levels and looks set to keep moving in that direction.

Despite the difficulties in this part of the oil operation–and low natural gas prices–Penn West’s overall funds from operations per share surged to CAD0.77, up from CAD0.67 a year ago. That produced a payout ratio of just 35 percent.

At this point, and given the dividend cut made at conversion, it looks like management is going to remain more committed to spending money on exploration and production than boosting its dividend. Capital spending hit CAD492 million in the quarter, up 87 percent from last year. And with the balance sheet the strongest in some time, there’s plenty of room to do a lot more without resorting to another acquisition.

Instead, the real appeal with Penn West is in the value of what’s in the ground, and management’s demonstrated ability to get it out and to market on its own or through alliances with deep-pocketed financial partners like China Investment Corp. That’s considerable. And coupled with the yield of nearly 5 percent, it makes Penn West Petroleum a superb growth and income play–and low risk bet on energy–all the way up to my target of USD30.

I’m also bullish on ARC Resources Ltd (TSX: ARX, OTC: AETUF) and Daylight Energy Ltd (TSX: DAY, OTC: DAYYF) as much for what they have in the ground as their dividends in the 5 percent range. Neither company has yet announced its first-quarter results. Both, however, came in with positive interim reports, showing solid progress in production and reserve development.

Both of these companies are volume plays. Thanks to prudent land acquisition strategies and technological development, they’re enjoying rising cash flow by virtue of increasingly output and cutting costs. They’d do better if natural gas prices gain strength in 2011. But even if prices stay flat or slip a bit, returns should be very positive.

I’m not forecasting dividend growth now, at least not until gas prices show some signs of life. But, trading near the value of their reserves, which makes them rare bargains, ARC Resources and Daylight Energy are buys up to USD26 and USD11, respectively.

Finally, TransForce Inc (TSX: TFI, OTC: TFIFF) isn’t set to report earnings until May 17. But the company’s venture with giant DHL Express promises to launch earnings much higher going forward. The deal calls for TransForce to purchase the DHL’s Canadian operations, an operation with CAD275 million in annualized revenue, as well as partner with DHL to offer a wide range of services.

In many way this deal signals TransForce coming to the big leagues after years of aggregating smaller competitors to build scale. And as it’s built size and strength, it’s become an increasingly valuable investment as well. The yield of around 3 percent isn’t eye-catching and the company is clearly more set on investing in growth and boosting payouts. But the up-and-coming transportation stock is a strong buy for growth and some income up to USD14.

Numbers to Come

As for the rest of the Canadian Edge Portfolio, we’re going to have to wait on reporting dates, most of which occur over the next couple weeks. I’ll have Flash Alerts throughout the month, generally within a day or two of when the numbers appear and as I’ve had time to digest what they mean.

Note that Macquarie Power & Infrastructure Corp is now Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF). There’s no change to your holdings, the dividend or guidance. Earnings are now slated to be released June 9. The stock’s still a buy up to USD9.

Here are announced dates for the rest of the Portfolio for earnings releases. Note dates can change, so stay tuned to my Flash Alerts, when I’ll be updating numbers:

Aggressive Holdings

• Ag Growth International (TSX: AFN, OTC: AGGZF)–Jun. 9 (confirmed)
• ARC Resources Ltd (TSX: ARX, OTC: AETUF)–May 19 (estimate)
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–May 10 (estimate)
• Daylight Energy Ltd (TSX: DAY, OTC: DAYYF)–May 18 (estimate)
• EnerCare Inc (TSX: ECI, OTC: CSUWF)–May 10 (confirmed)
• Enerplus Corp (TSX: ERF, NYSE: ERF)–May 13 (confirmed)
• Newalta Corp (TSX: NAL, OTC: NWLTF)–May 9 (confirmed)
• Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–May 13 (estimate)
• Perpetual Energy (TSX: PMT, OTC: PMGYF)–May 10 (estimate)
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–May 12 (estimate)
• PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)–May 20 (estimate)
• Provident Energy Ltd (TSX: PVE, NYSE: PVX)–May 11 (confirmed)
• Vermillion Energy Inc (TSX: VET, OTC: VEMTF)–May 20 (estimate)

Conservative Holdings

• Artis REIT (TSX: AX-U, OTC: ARESF)–May 18 (confirmed)
• Atlantic Power Corp (TSX: ATP, NYSE: AT)–May 11 (confirmed)
• Bird Construction Inc (TSX: BDT, OTC: BIRDF)–May 10 (estimate)
• Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF)–May 12 (confirmed)
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)–May 9 (confirmed)
• Capstone Infrastructure Corp/Macquarie Infrastructure Corp (TSX: CSE, OTC: MCQPF)–Jun. 9 (confirmed)
• Cineplex Inc (TSX: CGX, OTC: CPXGF)–May 12 (confirmed)
• Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)–May 10 (confirmed)
• Extendicare REIT (TSX: EXE-U, OTC: EXETF)–May 10 (estimate)
• IBI Group Inc (TSX: IBG, OTC: IBIBF)–Jun. 2 (estimate)
• Innergex Renewable Energy (TSX: INE, OTC: INGXF)–May 10 (estimate)
• Just Energy Group Inc (TSX: JE, OTC: JSTEF)–May 20 (estimate)
• Keyera Corp (TSX: KEY, OTC: KEYUF)–May 10 (confirmed)
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF)–Jun. 14 (confirmed)
• Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF)–May 26 (estimate)
• RioCan REIT (TSX: REI-U, OTC: RIOCF)–May 19 (confirmed)
• TransForce (TSX: TFI, OTC: TFIFF)–May 17 (confirmed)

As always, I’ll be using the numbers and guidance management provides in the earnings releases and conference calls to assess the health of each underlying company. Those that continue to measure up–as all of these have to date–will remain Portfolio Holdings. Those that exceed my expectations enough may earn higher buy targets.

On the other hand, those that don’t measure up will be unceremoniously unloaded. I’ll replace them with better companies when opportunity knocks. That’s how we’ll continue to weather the inevitable downturns while building wealth and reaping generous dividends, come what may in 2011 and beyond.