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AMM Dividend Letter (Volume 1)
AMM Dividend Letter
Vol. 1

Dear Valued Client,


Below you will find the inaugural issue of the AMM Dividend Letter. While our quarterly client letters typically focus on big picture items like the economy, Fed policy, and broad portfolio strategy, our goal for this monthly e-letter is to provide insight in to our thinking on the individual stocks that we are investing in on behalf of our clients. Each issue will include an update/analysis of a stock held either directly by clients or within one of the two publicly traded mutual funds that we manage.

Since we manage several different portfolio strategies, not all clients will have exposure to securities mentioned in this report. As always, don’t hesitate to call or email if you have any questions or if you want to discuss your specific portfolio strategy in greater detail. Additionally, we welcome any thoughts or suggestions you may have about how we might improve this communication in the future. We hope you find this monthly e-letter informative and insightful.

Sincerely,
Your Portfolio Management Team


The Importance of Dividends


Current Income to Owners:

Investors in common stocks own a pro-rata share of the companies in their portfolio and thus should think like owners. Many of our clients are business owners themselves, and once all expenses have been paid, and necessary funds have been retained for future growth, they typically pay a bonus or dividend to themselves. Large publicly traded companies effectively work the same way, they just have many more owners. While businesses may need to reinvest a portion of these profits for future growth initiatives, the remaining profits are available to pay out to shareholders in the form of dividends. While we don’t think companies should sacrifice growth just to pay a dividend, we do favor companies that have the ability to do both.

A History of Total Return*:

From 1926 through the end of 2012 stocks in the S&P 500 have annualized returns of 9.7% per year with 4.1% coming from dividends and 5.6% coming from capital appreciation. This ratio has varied over the years. In the 1940’s when stocks returned 9% per year, dividends accounted for wholly 2/3 of this return. In the lost decade of the 2000s, stocks in the S&P 500 annualized at negative .9% per year; however without the positive return of 1.8% provided by dividends, stocks would have lost -2.7% per year in the last decade. In all decades since 1926 dividends have provided an important component to a stock investor's total return.

Not only do we like the long-term prospects of dividend paying companies, but we think the current environment is uniquely positioned to benefit companies with rising dividend prospects. Research from Pew suggests that approximately 10,000 baby boomers are retiring every day. With interest rates on high quality investment grade bonds at generationally low levels, retirees and those investing for retirement are looking for ways to increase their income in retirement. Blue chip dividend paying stocks that offer both income and growth potential appear well suited for this challenge. Please contact us if you are interested in learning more about our dividend strategy and whether or not it is appropriate for a portion of your investment portfolio.

* Data points in this section provided by: Standard & Poor’s, Ibbotson & J.P. Morgan Asset Management


Dividend Stock in Focus

SLM Corporation (SLM): $25.37**


Profile:

SLM Corp. (also known as Sallie Mae) operates two distinct businesses related to the student loan industry: 1) Consumer Lending: originates, acquires, finances and services private student loans, and 2) Government Guaranteed Loans: manages a portfolio of private loans guaranteed by the government through the Federal Family Education Loan Program (FFELP). While the FFELP program was terminated in 2010, SLM Corp. continues to manage a FFELP loan portfolio of more than $118 billion on its balance sheet. Additionally, the company services loans owned by the Department of Education, and other guarantors of Federal Family Education Loan Program (FFELP) loans.

Dividend History:

From 1988 through 2006 SLM Corp. grew their dividend at a compound annual rate of 22% with only one annual reduction of the payout during the 2001 recession. However they reduced the dividend in 2007 and then eliminated the dividend completely from 2008 through 2010 as a result of the financial crisis. In 2011 they reinitiated a dividend of 30 cents per share and increased this amount by 66% to 50 cents per share in 2012.

Catalyst for dividend growth and price appreciation:

Earlier this year SLM Corp. announced that it will be spinning off its high growth, high return on equity private education loan business while the parent company will retain and manage its large student loan portfolio. The private bank, the spin off, will be named Sallie Mae Bank. The parent company will change its name to Education Loan Management. Splitting the company in two via a spinoff is a classic value creating strategy. Conceptually, the parts should be worth more than the whole, since investors can now value the high growth business independently of the operating performance of the slower growth business. The spinoff is expected to occur sometime in calendar year 2014. We outline the attributes of each post spinoff business below:

Education Loan Management (predictable cash flows, consistent return of capital to shareholders):

This entity will manage the cash flow from a student loan book that will amortize in 20 years and will remain the largest education loan servicer in the country. After accounting for operational expenses and discounting back the expected and reliable cash flows for the next 20 years we arrive at a value of $25 per share for Sallie Mae’s student loan portfolio. Ultimately, we expect Education Loan Management to return more capital to shareholders via share buybacks and dividends after the spinoff is completed. The potential exists for the value of Education Loan Management to increase if they are able to acquire more blocks of federally guaranteed student loans.

Sallie Mae Bank (high growth, high return on equity):

Sallie Mae Bank will retain the most recognized brand in the education loan industry, along with a leading market share (~47%) in private loan originations. We estimate the private bank business (the spinoff) is worth between $5-7 per share based on a comparison to similar publicly traded companies.

Based on our valuation analysis, the combined value of the two entities following the spinoff could be as high as $32 per share. Our 1 year total return target for this holding at time of our purchase was 25-30%***.

** Price as of October 31, 2013
*** Represents average price paid for clients invested in our Dividend Strategy. Depending on when a client joined the strategy they may have received a different price.


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