Expansion Mode

Expansion Mode Fall 2014 Expansion Mode is aimed at providing information and practical, proven tips to help professional and financial services executives expand their business and enhance their brand. We welcome your questions, comments, suggestions, and contributions.   Here’s to a successful 2014-15 for your business!  ...

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Northern Oil and Gas

Oil Boom is Big Boost for Northern Oil and Gas By Gene Walden From the Minneapolis Star Tribune Gasoline consumption has fallen off dramatically both domestically and around the world during the recession. But in North Dakota and surrounding states, a Wayzata-based company continues to pump up its balance sheet by participating in the exploration and drilling of newly discovered oil and gas deposits. Northern Oil and Gas (NOG) has only been active in the energy exploration process for about two years, but it expects to have a stake in about 100 drilling projects within the next year. “We expect them to experience dramatic profit growth in the next few years—even if oil stays at $50 a barrel,” explains Charles Mahar, president and CEO of Minneapolis-based Tealwood Asset Management. “We think the company is two years away from earnings of more than $2 a share, and its stock has been trading at just over $9 a share.” Northern Oil and Gas does not actually do the drilling. Rather, it leases mineral rights in strategic locations in the Bakken shale formation and Sanish shale formation areas primarily in North Dakota and Montana. It also helps pay the exploration and drilling costs. In return, it receives a share of the proceeds from the oil and gas produced in those areas. “The company has had a 100 percent success rate in the projects it has been involved with—and that’s un-heard of in this business,” says Dan Aronson, Tealwood vice president. “Their costs are probably about $20 a barrel for drilling and transportation and they can sell the oil for about $50 to $70 a barrel, so their economic model is very profitable. And they only need five professionals to run their core business.” Mahar cites Northern Oil and Gas as a prime example of the type of stock that should continue to perform well in the next stage of the stock market. “Over the past couple of years we’ve seen the whole market—good stocks and bad—fall together and recover together. But going forward, it’s going to be important to focus on specific stocks that have exceptional long-term expansion capabilities.” He said he looks for companies with what he considers to be the two most important variables—solid profit growth and a low price earnings ratio. “In other words, we’re looking for cheap stocks with high profit growth potential.” Mahar says the main reason stocks have performed so poorly in this decade compared with the 1990s is due to lower earnings and valuation levels. “We’ve seen 3 percent annual profit growth in this decade for Standard & Poor’s 500 stocks compared with 12 percent profit growth in the 1990s. Along with that, we’ve seen a 50 percent drop in price-earnngs ratios.” To find the winners in the next phase of the market, Mahar believes you need to find companies with the ability to increase their profits by at least 12 percent per year. In addition to Northern Oil and Gas, he holds a few other stocks he feels have strong profit growth potential: Patterson Companies (PDCO). The St. Paul-based operation is a distributor in the dental, veterinarian and rehabilitation supply markets in the U.S. and Canada. Its primary business is dental supplies, including such items as x-ray film, instruments, protective clothing, toothbrushes and related supplies. It also distributes lab supplies and related medical items for the veterinary business, as well as rehabilitation equipment and software. “Patterson is one of the companies we expect to continue to do well with annual earnings growth of about 12 percent for the next two years,” says Mahar. Patterson...

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The Purchase Decision

The Power of the Purchase Decision Benjamin Graham and the Power of Growth Stocks, 5th in a series “Price is what you pay; value is what you get.”                                     — Warren Buffett. The volatility of the stock market gives investors a continuous opportunity to trade their stocks at a favorable price if they are able to make their decisions based on value rather than emotion, according to author Frederick Martin of Disciplined Growth Investors. In his book, “Benjamin Graham and the Power of Growth Stocks” (McGraw-Hill), Martin says that investors should answer two questions before they decide the price they are willing to pay for a stock: 1.      What is the true value of the stock? 2.      What is your “hurdle rate”? There are a variety of ways to determine the value of a stock. We explained one method espoused by the late Benjamin Graham in an earlier column. But regardless of the method you use to value the stock, you need to hold true to that value, and let the movement of the market dictate the time or opportunity for you to buy that stock. The second question involves the “hurdle rate,” which is the average annual compounded rate of return you hope to earn from your investment portfolio. That rate can vary significantly from one investor to another. A conservative investor may choose a hurdle rate of 5 percent, while a more aggressive investor may shoot for 8 to 10 percent or more. How should you settle on a hurdle rate? Martin suggests that your hurdle rate should be determined based on your investment requirements and your ability to achieve those objectives. Once you’ve determined the ideal return you would need to achieve your objectives, Martin suggests you add about 2 percent for your hurdle rate to compensate for cyclical market downturns. So if you hope to achieve an 8 percent average annual return, you would set your hurdle rate at 10 percent. And once you’ve set it, don’t change it. “It’s important that you stick with (your hurdle rate) even though changing market and economic conditions will often tempt you to make a change,” writes Martin. “Unless your long-term goals have changed, you need to ignore the market conditions and maintain a nearly cult-like devotion to your hurdle rate.” In his book, Martin suggests that investors determine what the value of a company stock will be several years into the future. That way, when you are determining the price you’re willing to pay for a stock to meet your hurdle rate, you can figure in the price you need to buy the stock for today in order to achieve your hurdle rate in the years ahead. For instance, if you have a hurdle rate of 10 percent, and you determine that a stock will have a value of about $50 seven years from now, you should buy that stock only if you can buy it at a price that represents at least a 10 percent return over the next seven years. At a 10 percent annual compounded rate of return, the price would essentially double over the next seven years. That means you would need to buy the stock at $25 or less today to achieve a 10 percent return over the next seven years (assuming the stock performs true to your projections and reaches $50 a share). “By establishing a set hurdle rate, you are able to make the purchase process a very simple, straightforward decision,” explains Martin. “If you can buy the stock at a price that will give you a return that is equal...

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Mr. Market

The Magic of Mr. Market Benjamin Graham and the Power of Growth Stocks, 4th in a series It’s the magic of “Mr. Market” that gives stock market investors a unique benefit in buying and selling stocks at a favorable price, according to author Frederick Martin of Disciplined Growth Investors. “Mr. Market” is a concept first popularized by the late Benjamin Graham, who was known as the “Father of Securities Analysis.” Martin expanded on the concept of Mr. Market in his highly acclaimed book “Benjamin Graham and the Power of Growth Stocks” (McGraw-Hill). Martin compares the process of purchasing a car with the process of purchasing a stock. “The stock market is more volatile than the car market,” Martin writes. “Thus, the price of a company’s stock can diverge widely from the actual value of the company itself. This is the key opportunity for investors.” Another advantage, says Martin, is that the stock market is open for business every business day. “If you own a car and you decide to sell it, you must first find a buyer, and even then you have no assurance that you will receive your money in a timely manner.” In the stock market, you can sell a stock at any time, with absolute assurance that you’ll get your proceeds in three business days. “The fact that the stock market is continuously open for business presents a wonderful—and often perplexing—issue for investors,” writes Martin. Graham addressed this unique feature of the stock market in his book, The Intelligent Investor:  “Imagine that in some private business, you own a small share that costs you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers to either buy you out or sell you an additional interest on that basis. Sometimes his idea of value appears plausible and is justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes to you seems to you a little short of silly.” It’s those times when Mr. Market is a little too enthusiastic or a little too fearful when investors have the best opportunity to buy or sell their stocks at a favorable price. “If you are a prudent investor or a sensible businessman,” added Graham, “will you let Mr. Market’s daily communication determine your view of a $1,000 interest in the enterprise? Only in case you agree with him, or you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when the price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.” For patient investors, that means that good opportunities continue to come along as the market goes through its cyclical fluctuations. Unfortunately, most investors get caught up in the moment and allow themselves to be influenced by Mr. Market. When the prices Mr. Market offers begin to fall, instead of seeing value in the falling prices, investors tend to be influenced by fear that the prices will continue to fall. Instead of seeking out bargains to add to their portfolio, they let Mr. Market get the best of them, and start to sell off their holdings at the lower prices When Mr. Market begins...

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Margin of Safety

Margin of Safety Can Limit Stock Losses Benjamin Graham and the Power of Growth Stocks, Part 3 in a Series   “…To distill the secret of sound investment into three words, we venture the motto, ‘margin of safety’.” —Benjamin Graham Investors consider many factors in building their stock portfolios—diversification, P/E ratios, fundamentals, earnings growth, and timing, among others. But the most important factor of all may be one that investors often overlook—the margin of safety, according to author Frederick Martin of Disciplined Growth Investors. Buying a stock with a margin of safety means paying a favorable price that reduces the down side risk and increases the upside potential. To put it in simple terms, if you think a stock has a value of $10, for example, you would want to buy the stock at a price below $10 in order to give yourself a margin of safety. “Simply adding one more stock to the portfolio for the sake of diversification actually contributes nothing to your margin of safety,” explains Martin in his recent book, “Benjamin Graham and the Power of Growth Stocks” (McGraw-Hill). “Buying stocks without knowing the margin of safety can be tantamount to investment suicide.” It was the late Benjamin Graham who first introduced the concept of margin of safety to the investment world. Graham, an early stock market pioneer who may be best known as Warren Buffett’s mentor, introduced the margin of safety concept in his book, “The Intelligent Investor.” “To have a true investment, there must be present a true margin of safety,” wrote Graham. “And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.” Graham felt that a sufficient margin of safety could turn even a mediocre stock into a good buy. “It is our argument that a sufficiently low price can turn a security of mediocre quality into a sound investment opportunity—provided that the buyer is informed and experienced and that he practices adequate diversification,” said Graham. “For if the price is low enough to create a substantial margin of safety, the security thereby meets our criterion of investment.” Martin, on the other hand, is more interested in buying the stocks of great companies to hold for the long-term, which requires a more comprehensive analysis process. He needs to determine not just what the stock is worth today, but what it will likely be worth several years from now. Then he factors in the average annual returns he wants to earn by holding the stock (“hurdle rate”) and determines the price he would need to pay for the stock today to achieve his long-term objectives. KEYS TO BUILDING A MARGIN OF SAFETY Martin suggests that investors follow three key rules for building a margin of safety: 1.      Know what you own.  2.      Develop reasonable estimates of future value.  3.      Set a reasonable hurdle rate.  Step one (know what you own) means doing the proper due diligence on the stock you’re interested in buying. Research the company thoroughly and determine if it’s really a company you want to own for the long term.  Step two (develop reasonable estimates of future value) means looking at the company’s future prospects and projecting a future growth rate to determine the company’s potential value several years from now. Martin, the president and chief investment officer of Disciplined Growth Investors in Minneapolis, prefers to use a seven-year time frame in setting the margin of safety for the stocks he buys. That means calculating an estimated intrinsic value for the target company seven years...

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Avoiding Family Cabin Disputes

Cabin Fever By Gene Walden From The Minneapolis Star Tribune The lake cabin. It’s place where families come together to bond, boat and share good times—the great American dream Minnesota style. Unfortunately, it can also become the great American nightmare. When cabin owners pass their cabins onto siblings or other relatives, it can create such disharmony that those special bonds are broken and the good times turn to ill will and even law suits. One cabin owner left his cabin to three nieces from different families who were not the best of friends. The three have been squabbling over minor issues ever since. “They’ve already spent almost as much in legal fees as the cabin is worth,” said Susan Link an estate and trust attorney with the Minneapolis-based Maslon law firm. Link has seen more than a few family feuds over cabin issues. While some cabin disputes are unavoidable, there are steps a family can take to keep the disharmony to a minimum. “You need a structure that puts someone in charge or a mechanism that forces the sale of the property if they can’t work it out,” says Link. “What you shouldn’t do is leave everything to the three kids and leave all three in control. You need to name one child as the executor (or personal representative). That’s probably my most important piece of advice.” While the lake cabin can be a great get-a-way for a close family, a lot can go wrong when mom and dad pass it down to siblings or other relatives, says Link: * The children get the cabin, but one of them moves away and doesn’t want to pay as much for upkeep. * The children get the cabin and use it equally with no problem. But one of the siblings dies and his or her spouse remarries. That can make for an awkward reunion. * Only one of the siblings really wants to use the cabin, but can’t afford to buy out the other siblings. * All the siblings want to use the cabin, but they don’t always agree on how much to spend on maintenance and renovations. There are some common solutions to some of those issues, but they generally require careful planning. For instance, there may an easy resolution when only one sibling is really interested in using the cabin but can’t afford to buy out his or her other siblings, says Link. “This is a mathematical problem—not an emotional issue. He may be able to buy out the other siblings over time or take out an equity loan using the cabin as collateral to buy them out.” But other conflicts may not be so easy to resolve. For instance, if the parents leave the cabin to their three sons, things may work fine for many years—the sons and their families agree on a rotating schedule to use the cabin and all contribute equally to clean-up and repairs. “But what happens when one of the sons gets divorced?” asks Link. “That piece of property is brought into the divorce. In Minnesota, even if only the husband’s name is on the deed, the wife still has marital rights to the property. If the property is sold, she still has to sign the deed.” You can avoid that problem, says Link, if the parents set up a family trust. The cabin is held in the trust and the kids are given control of the trust. “A spouse normally does not have an interest in a trust. If a sibling dies, their share stays in the trust, so if the cabin is...

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