The Dividend Stocks of the Ultimate Stock Pickers

Morningstar is out with their lists of the highest-yielding and widely-held dividend paying stocks of their Ultimate Stock Pickers.

The top ten highest yielding owned by Morningstar’s Ultimate Stock Pickers.

Table courtesy of Morningstar. Click image to enlarge.
Table courtesy of Morningstar. Click image to enlarge.

And the most widely held dividend paying stocks by Morningstar’s Ultimate Stock Pickers.

Table courtesy of Morningstar. Click image to enlarge.
Table courtesy of Morningstar. Click image to enlarge.

Source:

4 Dividend-Payers From the Ultimate Stock-Pickers (Morningstar)

AMM Dividend Letter Vol. 25: 2016 Prediction & Year-End Review

This is from the AMM Dividend Letter released January 7, 2016. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing list here.

Predictions. We humans love listening to, making, and trusting predictions. Since it’s the start of a new year we’re going to be inundated with a lot of predictions about the year to come. The thing is we are really bad at making predictions; especially stock market predictions.

The chart below, from Morgan Housel’s The Blind Forecaster, shows the average wall street strategist’s forecast for S&P 500 returns each year compared to the actual gain/loss in the S&P 500 for that year since 2000.

Chart courtesy of the Fool.com. Click image to enlarge.
Chart courtesy of the Fool.com. Click image to enlarge.

According to Morgan Housel, the average Wall Street strategist was off by 14.7 percentage points a year! And these guys and gals get paid the big bucks.

What if you simply took the S&P 500’s long-term average return of about 9% and used that as your guess? Morgan Housel took a look at this too and this strategy beat the pros, but you still would have been very wrong. Your forecasts would’ve been off by 14.1 percentage points per year.

Dynamic System

Why is it so hard to make stock market forecasts? It seems fairly easy right. Get a reasonable estimate of earnings for 2016, apply a basic multiple, and voila you have the S&P 500 target price and the return for the year. It’s that easy!

Not quite. The stock market is a dynamic system. It is an interplay between millions of moving parts and participants. Like the weather, another dynamic system, each little change ripples throughout the system causing large and unforeseen effects rendering predictions useless.

It’s the butterfly effect; a butterfly flapping its wing in some far off place causes a hurricane. Or to put it another more official way.

In chaos theory, the butterfly effect is the sensitive dependence on initial conditions in which a small change in one state of a deterministic nonlinear system can result in large differences in a later state.

Always Know Your Base Rate

If we’re planning a trip to San Diego 6 months from now we don’t need to know exactly what the weather will be like. We can reasonably expect the weather to be sunny and about 71 degrees Fahrenheit, the average June climate in San Diego. We can make this reasonable assumption because we have centuries of weather data that we can average. This is called the Base Rate.

The long-term average return of the S&P 500 is a reasonable base rate for stock market returns. Once an investor knows the base rate, they should then determine whether they have any special knowledge to adjust the base rate up or down to make a better prediction. Given the poor track record of Wall Street strategists who are literally paid to make these predictions, we should assume we have no special knowledge. In this case, all investors should simply use the base rate.

We don’t need to come up with a better prediction than the long-term average returns for the equity markets. We’re not trying to get in and out of the stock market at just the right time. Because the markets are dynamic systems, a decision to sell one day will look completely foolish the next. All the buying and selling leads to more transactional fees, a guaranteed loss of your money.

Think Probabilistically

We also enter 2016 knowing that the market will not likely return its exact average (i.e. the base rate) for the year. It rarely ever does as the chart below shows.

Chart courtesy of A Wealth of Common Sense. Click image to enlarge.
Chart courtesy of A Wealth of Common Sense. Click image to enlarge.

The other big issue with market predictions, and maybe why investors are inclined to trust them so much, is that the people who make them are typically both confident and very specific. In fact as the data show, the forecasters are terribly overconfident in their ability to make predictions. In dynamic systems like the stock market, it is better to think probabilistically with a range of potential outcomes as opposed to trying to predict a single outcome.

To be as confident as the other market prognosticators, we want our range of outcomes to fall within the 95% confidence interval. The following is our prediction of probable returns for the S&P 500 in 2016. Feel free to use this prediction to wow your friends with your clairvoyance.

The S&P 500 will return between -25% and +25%!

And you wonder why CNBC has not called us to appear on TV yet.

How is This Useful?

What can anyone do with this prediction

While the range we give is wide the actual skew of the distribution curve is shifted more towards positive returns. Even though no one knows what the stock market will do each year the odds favor positive returns and, over longer time periods (10-30+ years), the odds greatly favor positive returns. Also, the longer the time period the tighter the range of probable return outcomes with a clear shift towards more positive outcomes.

Image courtesy of Barrons. Click image to enlarge.
Image courtesy of Barrons. Click image to enlarge.

And that’s what you do. You make a plan to save and invest for a long period of time, 10+ years, and then stick to the plan. You avoid the Siren’s call to trade around yearly market predictions. It is the best way to keep the odds ever in your favor.

Happy New Year!

Your Portfolio Management Team

Novartis (NVS) from Volume 13

Novartis is a large well-diversified pharmaceutical company. It operates in branded pharmaceuticals, generic pharmaceuticals, eye care, and consumer health.

Novartis’ branded drug divisions had its heart failure drug, LCZ696, approved in the U.S. and EU and officially named Entresto. Sales are off to a strong start and peak sales are expected to top $5 billion. Cosentyx, an immunology drug, was also recently approved and its peak sales are expected to reach $2 billion.

Sandoz is Novartis’ generic drug division. It is one of the biggest generic businesses in the world and will receive a boost from the billions of dollars worth of branded drugs losing their patents over the next 5-10 years. Part of this growth will come from the new and developing biosimilar market, “generic” versions of biologics. Many of the world’s first and extremely profitable biologics, e.g. Amgen’s Neupogen, have gone off patent and generic drug companies like Sandoz are selling their cheaper versions.

At the current price around $84 per share the market is undervaluing the potential of Novartis’ branded drug pipeline, generic drug opportunities, and the return of growth to its eye care division, Alcon.

BlackRock Inc. (BLK) from Volume 14

From December 1, 2015 to December 14, 2015 BlackRock (BLK) lost about 11% of its market cap. During this time, another famous asset manager Third Avenue Management had to shut down its Focused Credit Fund (TFCIX) because of mounting withdrawals and the lack of liquidity in the junk bond market. BlackRock runs one of the largest junk bond ETFs (JNK). Never missing a chance to throw the baby out with the bathwater, BlackRock shares sold off even though JNK represents only 0.22% of BlackRock’s total AUM. To be fair, whatever affects the overall bond and equity markets affects all of BlackRock’s business but to be hyper-concerned about one ETF is too narrow of a focus.

BlackRock is the world’s largest asset manager and is well balanced between fixed-income and equities, including both active and passive strategies. We expect short-term market gyrations and fears to present more opportunities to add to our position in BlackRock.

*Volume 15 was the 2014 year end review

General Electric (GE) from Volume 16

General Electric had a busy year. It jumped through all of the regulatory hoops to buy French company Alstom’s power business. GE had a deal to sell its appliance business to Electrolux only to have U.S. anti-trust regulators nix the deal. CEO Jeff Immelt says he expects to find another buyer at the start of 2016.

In 2015, GE finalized the spin-off of Synchrony Financial. We were hoping to get GE’s remaining 85% stake spun-off directly to current shareholders, but that didn’t happen. GE did an exchange offering whereby it offered to sell SYF shares to current GE shareholders at a 7% market discount. Then GE would use the cash raised to buy back more of its own shares, about 7% of its then shares outstanding. We declined to participate in the offering. We wanted to maintain our complete position in GE to participate further in its restructuring and plans for returning more capital to shareholders.

GE sold its commercial lending and leasing business, the last big chunk of GE Capital, with $32 billion in assets to Wells Fargo. The bulk of the proceeds from the sale will go to returning capital to shareholders.

Finally, GE received a boost when activist investor Nelson Peltz and his Trian Fund announced they owned 1% of GE. Mr. Peltz then publically said they are in agreement with everything Jeff Immelt is doing and their new stake is not an activist stake.

Norfolk Southern (NSC) from Volume 17

When we discussed Norfolk Southern we mentioned that the failed merger of Canadian Pacific (CP) and CSX (CSX) opened the door for Norfolk Southern to be involved in a deal. Then in early November Candian Pacific announced that they would like to buy Norfolk Southern in a $28.4 billion deal. NSC rejected the offer because it did not “fairly value” the company and NSC management does not think the deal will pass anti-trust regulation. Canadian Pacific revised its offer on December 16, 2015, to include a bonus payment of up to $3.4 Billion to NSC shareholders if the combined company’s shares are not worth $175 by October 2017.

Then the CEO of Berkshire Hathaway owned BNSF made the statement that they would be interested in making a competing offer for NSC. There are so few Class 1 railroads left that if the industry begins another round of consolidation then all operators have to get involved.

Finding the right dollar amount or the right bidder to get the deal done are not the biggest issues. Given the high level of concentration in the industry the railroad operators face large anti-trust/regulatory hurdles to any prospective merger. While we think the optimum number of Class 1 operators is two, we don’t think there is a high probability that the regulators will see it that way.

If/when NSC is bought it will take a long time for the deal to consummate (likely a year at minimum). In the meantime, we will continue to buy NSC below our estimate of fair value and wait to see what happens with any potential merger deals.

PayChex (PAYX) from Volume 18

The big news for PayChex is that the Federal Reserve raised short-term inerest rates. PayChex’s payroll processing service takes control of its clients’ funds before distributing it out to its clients’ employees. Like insurance companies these funds become float or cash in PayChex’s accounts that it can earn interest on. Unlike insurance companies that can invest their float for long periods of time because their liabilities are many years into the future, PayChex’s float is extremely short-term. PayChex has to balance the ability to earn interest on their float with the short-term liabilities of their Clients’ payroll. PayChex does this by buying short-term paper like 1-3 year U.S. Treasuries, 1-3 year corporate bonds, and commercial paper.

Before the current low-interest rate environment, PayChex used to earn a blended yield of 4% on funds held for clients. Now that blended yield is 0.9%. Higher rates will allow PayChex to earn more interest income on funds held for clients. We don’t expect to reach pre-2007 interest rates levels for some time. If the Federal Reserve continues to raise short-term rates then one of PayChex’s most profitable divisions will benefit greatly.

ExxonMobil (XOM) from Volume 19

ExxonMobil is the only remaining position we have in the oil supermajors. As we highlighted, ExxonMobil has one of the lowest breakeven price points in regards to the price of oil to cover operational costs and its ability to continue to pay its dividend. ExxonMobil’s revenue and income are balanced between upstream operations (exploration and production), and downstream operations (refining and marketing). ExxonMobil was even able to grow its dividend this year by 6%. The company also has room on its balance sheet to make a large acquisition of another oil company during this period of industry stress. Management has successfully done this during past oil bear markets.

ExxonMobil is the largest oil and company and its fortunes are tied to the price of oil. When oil prices rise ExxonMobil’s cash flow and share price will rise with it. As long as oil prices remain low, ExxonMobil will be under pressure. Our job is to monitor ExxonMobil’s financial statements for its ability to maintain its current dividend policy and ExxonMoibl’s ability to grow its dividend well into the future. If things change to the point that ExxonMobil cannot maintain the dividend policy then we will sell.

Philip Morris (PM) from Volume 20

Philip Morris is probably the most controversial position we own. For those clients who’ve requested not to own any tobacco stocks we understand your position and we have not bought Philip Morris for your account. Tobacco stocks have been unloved for a long time. It is the general disdain that has kept the price of shares in tobacco companies well below their intrinsic value. In general, tobacco companies need very little capital to grow and maintain their business. Tobacco companies also turn their inventory over so quickly that they generate high returns on invested capital and even higher returns on tangible capital. Philip Morris is no exception. The excess returns and low capital needs mean more capital can be returned to shareholders through increased dividends and share buybacks. Combined with the low price to intrinsic value equates to higher shareholder returns over time.

One of the biggest threats to Philip Morris and the other tobacco companies is plain packaging laws circulating among the world’s legislators. It looks like Philip Morris and other tobacco companies will lose their challenge to the EU’s top court plain packaging laws. Other countries will follow suit. Advertising and brand building allows Philip Morris to charge premium prices. When cigarette packages all look the same will Philip Morris be able to charge premium prices?

Baxter International (BAX) & Baxalta (BXLT) from Volume 21

As soon as the spin-off of Baxalta from Baxter occurred both companies experienced positive catalysts. Activist Investor Dan Loeb of Third Point took a 10% stake in the new Baxter (BAX). Mr. Loeb and his investment firm sought and received a position on the company’s board and a role in bringing in a new CEO. The new CEO, Jose Almeida, is a proven deal maker. He became CEO of Covidien in 2011 and built a truly global company through a series of acquisitions and growth initiatives. Then Mr. Almeida sold Covidien to Medtronic for $49 Billion in 2014.

Baxalta upon separation from Baxter immediately received a $30.6 Billion buyout offer from Shire Plc. Baxalta rebuffed the offer stating it was too low and that they had no interest in doing a deal. Shire Plc maintained their interest and the persistence paid off as management from Baxalta and Shire met recently to discuss terms. Because of Baxalta’s recent spin-off and to maintain its tax-free status the deal will involve a mix of Shire shares and cash. With more shares than cash. If/when a final deal is announced we’ll decide whether we want to maintain our position in the new company or sell our position.

Union Pacific (UNP) from Volume 22

The concerns facing Union Pacific are: slowing economy/recession, lower oil prices, lower commodity prices. We made our first purchase of UNP in the face of these headwinds and the environment is still the same. Railroads remain the most efficient way to move goods over long distances within the U.S. Short-term economic fluctuations will weigh on UNP’s stock price. However, in the long-run we expect the U.S. economy and global economy to continue to grow and railroads will be there to transport the goods.

Johnson & Johnson (JNJ) from Volume 23

Nothing new to report since we first wrote about Johnson & Johnson. An acquisition of a biotech company is still a possibility with valuations of potential targets still coming down. If Johnson & Johnson does not make an acquisition in the coming year we would like to see a more aggressive return of capital to shareholders. Interest rates are still extremely low and JNJ has the room on their balance sheet to take on more debt to finance aggressive share buybacks and/or a special dividend to shareholders.

The Walt Disney Co. (DIS) from Volume 24

Disney was the subject of our most recent letter so there is nothing new to report. Except that Star Wars VII: The Force Awakens is destroying box office records as if they were a Death Star getting proton torpedos sent into its thermal exhaust port by a rebel X-Wing fighter.

All previous letters are archived here.

The opinions expressed in “The AMM Dividend Letter” are those of Gabriel Wisdom, Michael Moore and Glenn Busch and do not necessarily reflect the opinions of American Money Management, LLC (AMM), an SEC registered investment advisor who serves as a portfolio manager to private accounts as well as to mutual funds. Clients of AMM, Mr. Wisdom, Mr. Moore, Mr. Busch, employees of AMM, and mutual funds AMM manages may buy or sell investments mentioned without prior notice. This newsletter should not be considered investment advice and is for educational purposes only. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything. Current stock quotes are obtained at http://finance.yahoo.com. Prices are as of the close of the market on the date for which the price is referenced.

Systems Versus Goals & Year-End Review

This is from the AMM Dividend Letter released January 8, 2015. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing list here.

It’s that time of the year again. When we sit down and make our New Year’s Resolutions. A fancy way of saying we’re going to set some goals for the coming year. One of the more common resolutions/goals people make is “to save more money”.

Financial Resolutions
From Most Americans Want to Save More in 2015 – But Can They? by Mandi Woodruff

Saving more is a great goal but how will we accomplish it?

It’s about systems versus goals. A goal is the end. The system is how you get there. The beauty of a system is even if you fall a little short of your goal you have still accomplished a great deal.

A sports team wants to win the championship. A goal. The daily practices, conditioning, video sessions, etc. designed by the coaches are the system to reach this goal. Even if the team falls short of their goal of winning a championship they still have improved immensely as a team because of the system.

The system needs to be easy and simple to follow at first to ensure compliance and then easily built upon.

The system also needs to be a combination of improvement by subtraction and improvement by addition. Improvement by subtraction is eliminating the bad habits. If your goal is weight loss then improvement by subtraction is removing the junk food from the pantry and not buying any more of it. Improvement by addition is getting better by doing things better and doing more of it. If your goal is to get in shape then you would add few workouts a week and then slowly add more to each workout and more workout days per week.

It is the same with saving money. If people really want to save more money then they need to create a system to do so.

1) Make the system easy to follow

Automatically have money taken out of your paycheck to go to a 401K or other retirement program so you don’t have to think about doing it. After a paycheck is deposited into your bank account use the bill pay feature to set-up a recurring payment to have money sent out to other savings accounts. The goal is remove your willpower out of the equation and to make savings as automatic and unconscious as possible.

2) Improvement by Subtraction

Use Mint, Quicken, or any other budget system to track what you’re spending. Where can you cut excess spending? Don’t just focus on the small things like cutting out one Starbucks latte per week. What about the big stuff like transportation, housing, or cable?

3) Improvement by Addition

Every year try to increase the percentage of your salary saved. Can you earn more money? Is it time for that raise at work? Can you turn a hobby into a side business? If you’re reading this letter you have already implemented a strong improvement by addition element to your savings system.

Dividend growth investing.

It is a system focused on earning more money every year. You are letting the management teams of the companies you own do the arduous day-to-day tasks of running a business while you get to collect a quarterly dividend from the business. You also have hired us to select the underlying investments. Our goal is to buy high quality companies with a market leading position that can grow their dividend year-in and year-out.

For 2014 the average dividend growth across the entire portfolio was 10.37%.** If you are able to achieve this kind of income growth consistently you will double your dividend income in 7 years, triple it in 11, and quadruple your income in 14 years. While there is no guarantee that we can achieve this level of dividend growth going forward, we will continue to do our best every day to build a strong dividend growth stream on your behalf.

When you sit down to make resolutions for 2015, financial or otherwise, make sure you spend more time on developing the systems rather than the goals themselves. Your chances at success will greatly improve.

Happy New Year!
Your Portfolio Management Team

*For more on creating systems and other tips to help achieve your goals head over to James Clear.

**This figure encompasses the annual dividend growth of all positions held in the Dividend Strategy portfolio as of 12/31/13. Not all investors in the Dividend Strategy as of 12/31/13 held all positions as of this date (specifically, newer investors who were not yet fully invested in the strategy and/or investors who have restricted us from investing in particular industries, did not own all positions as of this date) and therefore it is likely they achieved a lower dividend growth rate in 2014.

Year-End Review

We’ve been writing the AMM Dividend letter for over a year. Below we have provided a review on some of the investments that we have highlighted along with updates on our current view.

In chronological order:

SLM Corp (SLM) from Volume 1 October 31, 2013

Dividend Per Share Growth Since Write Up: 0%

We focus on 3 core types of dividend payers when building your portfolio: Dividend Stalwarts, New Dividend payers, and Restructuring/Special Situations. Our SLM Corp investment was a restructuring. The company was going to split into Navient (NAVI) and SLM Corp. (SLM). Navient would manage the cash flow from an existing book of student loans that would amortize over 20 years. The new SLM Corp. would become a small bank specializing in selling private student loans. Our original analysis valued the pre-split SLM Corp at $32 per share and we made our first purchases back in June of 2013. The split then occurred in April of 2014. We sold Both Navient and SLM to fund our recent purchase of BlackRock (BLK).

We sent out a special portfolio update back in October discussing our reason for selling Navient and SLM Corp to buy BlackRock and you can read it again by following the link below.

Portfolio Update ~ Selling Navient (NAVI) and SLM Corp. (SLM)

Wynn Resorts (WYNN) from Volume 2 from November 30, 2013

Dividend Per Share Growth Since Write Up: 25%

Wynn was one of our better performing stocks in 2013 and the early part of 2014. Gambling in Macau continued to rise for both VIPs and the mass market and earnings estimates and target prices rose with it. Then in May of 2014 a Macau Junket operator went missing with about $1.3 billion of its clients’ money. Unlike Las Vegas, the VIP market in Macau operates through junkets, companies that bring the VIPS to the casinos. The junket operators issue the VIPs credit and collect on the player’s debts. In exchange the junket operator gets a commission on the amount gambled at the casino. Wynn did not have direct exposure to this operator but it does deal with other junket operators. The disappearance spooked VIP gamblers and the amount of VIP money being gambled at Macau casinos dropped.

In response President Xi Jinping announced a crackdown on corruption which also targets the junket operators. Cheung Chi Tai one of the largest junket operators had his assets frozen and the FBI is monitoring him for potential connections to the Triad, China’s mafia. VIP gambling dropped even further and Macau is experiencing its first negative year-over-year growth in VIP gaming.

The bright spot according to Goldman Sachs is while 56% of Macau’s gaming revenue comes from the VIP market only 22% of EBITDA (earnings before interest taxes depreciation and amortization) comes from VIPs. The rest comes from mass market gaming. Wynn has positioned itself as the Macau luxury brand which attracts the VIPS but also the higher end of the mass market that wants a taste of luxury. Luxury anything gets to charge higher rates and attracts more money. Wynn consistently has the highest revenue and EBITDA per gaming table.

In 2016 the Wynn Palace will be completed doubling Wynn’s gaming tables and adding another 2,000 rooms to their operations in Macau. We also expect the capital expenditure requirements for Wynn to lower after the completion of the Wynn Palace. More gaming and room revenue coupled with less capex should allow Wynn to continue to increase both its quarterly and year-end special dividend.

Additionally, Wynn’s Las Vegas operations continue to improve as the U.S. economy climbs out of the doldrums. The company recently won the right to build a gambling resort outside of Boston. The Boston casino is estimated to cost $1.6 billion and it will pick-up some of the reduced capex spending in Macau.

There is little doubt that the anti-corruption crackdown in Macau will carry over into 2015 but even with these headwinds Wynn increased its quarterly dividend by 25% and made a special year-end dividend of $1.00 per share.

We may look to add more to Wynn on additional price weakness; however we are watching closely for a turn in the fallout from the anti-corruption crackdown.

Qualcomm (QCOM) from Volume 3 from January 1, 2014

Dividend Per Share Growth Since Write Up: 20%

Qualcomm has taken a hit recently on the news that it is facing an anti-trust probe in China, Europe, and even by the U.S. Federal Trade Commission. The target is Qualcomm’s extremely profitable royalty business. Qualcomm charges cell phone makers royalties on any phones that use Qualcomm’s patents to connect to wireless networks. This is pretty much every cell phone made. The probe in China came from the communist party’s regulatory mouthpiece indicating that party connected Chinese cell phone makers do not want to pay Qualcomm for using their patented technology. In fact Qualcomm recently has been having a hard time collecting royalty revenue from said cell phone makers as they use their political connections to reduce their royalty burdens.

It’s the same issue with the U.S. and European probes. Qualcomm put the time, money, and research into building a quality product and without it your cell phone and all the data it consumes wouldn’t be possible. Given how so many of us rely on our cell phones Qualcomm should actually charge more in royalties given the demand for its product.

While we fully expect the Chinese investigation and uncollected royalty payments to be resolved, it remains unclear whether or not Qualcomm will be fined by Chinese regulators and, if so, by how much. The uncertainty of the resolution also revolves around any new royalty fee structures for Chinese cell phone makers. If the Chinese cell phone makers get to pay less in royalties will non-Chinese cell phone makers agitate for lower royalty payments too? Short-term market participants don’t like uncertainty and Qualcomm’s share price has taken a hit.

If a new lower royalty rate happens we will reevaluate our fair value of Qualcomm. Even so, the secular global growth of cell phones, smart phones, 3G, and 4G networks puts Qualcomm in an enviable spot. The royalties should still provide tremendous free cash for Qualcomm to return capital to its shareholders via dividend growth and share buybacks.

We recently did another purchasing round of Qualcomm to add it to new accounts and any account that was underweight the position. If prices remain around here or drop further we will likely do another round of buying.

Apple (AAPL) from Volume 4 from February 1, 2014

Dividend Per Share Growth Since Write Up: 7.8%

When we originally discussed our position in Apple the stock was trading around $500 per share. Since then the company split the stock 7-for-1 and increased its capital return program to a total of $130 billion. Part of this increase will be another $30 billion increase to share repurchases along with the 7.8% increase to its dividend. Even more critical to us as dividend growth investors is Apple’s stated intention to increase their dividend every year.

Additionally, the Board has approved an increase to the Company’s quarterly dividend of approximately 8 percent and has declared a dividend of $3.29 per common share, payable on May 15, 2014 to shareholders of record as of the close of business on May 12, 2014. The Company also plans to increase its dividend on an annual basis. With annual payments of $11 billion, Apple is among the largest dividend payers in the world.

-From Apple’s April 23, 2014 press release

Since our write-up Apple released its iPhone 6 and its new larger screen version, the iPhone 6 Plus, to tremendous demand. In its first weekend of sales, Apple sold a record breaking 10 million units and demand is still outpacing supply. Even better is the higher average selling price (ASP) for the new iPhones which should push Apple’s margins back up and generate more free cash flow for the company.

We mentioned Apple leveraging their reach and iTunes accounts to move into mobile payments. Along with the launch of its new phones Apple also announced Apple Pay, its foray into mobile wallets and payments. Mobile wallets are nothing new but Apple has the reach and cache to push greater adoption of the technology. Look at all the new bank commercials highlighting their compatibility with Apple Pay. Adoption rates so far have exceeded expectations and this is a very good thing for Apple. For every transaction through Apple Pay, Apple receives a small cut of the interchange fees charged by banks. The costs for Apple to run Apple Pay are so small that most revenue generated by Apple Pay turns into cash flow. As adoption rates for Apple Pay continue to grow so will Apple’s cash.

All this good news pushed Apple’s share price and investor sentiment to all-time highs.

We are not making any new purchases right now. If we see a large correction in Apple’ stock then we will consider adding to our position.

AbbVie (ABBV) from Volume 5 from March 1, 2014

Dividend per Share Growth Since Write Up: 5%

Humira continues to be the cash cow for AbbVie but the main concern is the drug goes off patent starting in 2017. Any patent loss is a concern but as we discussed in our initial write-up, Humira is a biologic not a chemically synthesized drug. A biologic is a very large drug that is made through the help of microorganisms by splicing DNA into them. It is a much harder process to replicate and it is a very expensive process. This will dissuade some generic drug makers from trying to make Biosimilars (generic copies) of Humira. Those generic drug makers that do succeed still won’t be able to charge too much of a discount to Humira because of the development costs.

AbbVie still needs to diversify its approved drugs and its pipeline for future growth. To achieve this and reduce its overall tax structure, AbbVie tried to buy Ireland based Shire plc (SHPG) in a tax inversion deal. Congress then decided to make it harder for US companies to move their headquarters overseas after buying a foreign company. The proposed rule changes by congress made the deal for Shire plc unworkable and AbbVie dropped their buyout offer after having to pay a large break-up fee of $1.6 billion.

AbbVie’s Hepatitis C drug was approved by the FDA last week and will be sold at price point below Gilead’s leading Hepatitis C treatment. Express Scripts, the largest U.S. pharmacy benefit management company, then dropped Gilead’s Hepatitis C drug Sovaldi in favor for AbbVie’s Viekira Pak. This should help AbbVie take market share and meet sales estimates but the underlying concern is a price war between Hepatitis C drugs.

We are not making any new purchases right now as the stock is trading slightly above our estimate of fair value. If we get a large correction in the stock then we will look to buy some more shares.

Lorillard (LO) from Volume 6 from March 29, 2014

Dividend Per Share Growth Since Write Up: 0%

One of the catalysts for capital appreciation that we discussed was a potential merger between Lorillard and Reynolds American (RAI). At the time when we wrote about Lorillard the merger rumor was just that, a rumor. Sources then confirmed the two companies were working on a deal. All that was left was making it official. Expectations had Reynolds American offering over $70 per share for Lorillard. The official offer came in at $66 per share in a mix of cash and stock. The market was underwhelmed to say the least. Lorillard sold off back to about $60 per share and languished there for the last many months. Recently Lorillard has been creeping back up in price and it has still been paying a dividend. However, management has held off on increasing the dividend while they work through the merger with Reynolds American.

We’re not making any new purchases but we are holding through the merger. The merger is not a done deal and there are risks that the deal falls apart. For one, there are still a lot of regulatory hurdles to get through. A combined Lorillard and Reynolds American creates a huge tobacco company and reduces competition. U.S. regulators don’t like this. The usual concern is less competition leads to increased prices hurting the consumer. However, lawmakers don’t want people to smoke and they have been raising taxes on tobacco to artificially raise prices on cigarettes to get people to stop smoking. Wouldn’t they want tobacco companies to raise cigarette prices?

Anheuser-Busch InBev (BUD) from Volume 7 from May 3, 2014

Dividend Per Share Growth Since Write Up: 7.4%

One of the issues facing Anheuser-Busch InBev is declining U.S. sales in its flagship brands, Budweiser and Bud Light, in part because of the explosive growth in craft beers. To counteract declining sales and to gain more exposure to craft brewing Anheuser-Busch InBev has been buying established craft brewers. These are usually older craft brewery brands that are looking for the capital to better compete with the newer craft brewers. Anheuser-Busch InBev has the capital and the distribution system to achieve both goals. Anheuser-Busch InBev had already acquired Goose Island (the maker of one of Glenn’s favorite beers, Matilda) and Blue point Brewery when we wrote volume 7 of the AMM Dividend Letter. Then last month Anheuser-Busch InBev bought another craft brewer, Oregon’s 10 Barrel Brewing.

The second step in combating declining U.S. sales of its flagship brands is to refocus its advertising, especially for Budweiser. Some 21-27 year olds, a prime beer drinking demographic, have never had a Budweiser. The company that has produced some of the more memorable advertising campaigns is shifting their focus back to this important drinking demographic. If Pabst Blue Ribbon, the original nemesis to Anheuser-Busch, can gain traction in the 21-27 year old crowd with minimal advertising Budweiser can regain some luster with a national campaign.

Anheuser-Busch InBev is so large that there are few markets where it doesn’t have a strong presence except in the faster growing African markets. SABMiller dominates these markets right now. This is one of the reasons why the Anheuser-Busch InBev buying SABMiller rumor has persisted for so long. The rumors became a little louder this summer when SABMiller’s offer to buy Heineken was rejected. It was seen as a move by SABMiller to make it too large for Anheuser-Busch InBev to buy. It was the same tactic used by August Busch IV when Interbrew wanted to buy the original Anheuser-Busch. We would like Anheuser-Busch InBev to buy SABMiller. A merger would be fertile ground for the Brazilian management team of Anheuser-Busch InBev to cut costs, improve efficiency, and produce strong rewards for its shareholders.

We are still buying Anheuser-Busch InBev on short-term price pullbacks around $100-$105 per share.

McDonald’s (MCD) from Volume 8 from May 31, 2014

Dividend per Share Growth Since Write Up: 4.9%

McDonald’s has been besieged with problems lately. There was the Chinese meat supplier found repackaging old meat. Then Russia shutting down restaurants and “inspecting” many more in retaliation to western sanctions over Ukraine. Then there is the ongoing declining Same-Store-Sales exacerbated by the above events.

Despite all that McDonald’s still has a 49.7% share of the U.S. fast food hamburger market. McDonald’s is still the most profitable quick serve restaurant company in the world. Then there is all that real estate McDonald’s owns.

The main issue with McDonald’s right now, the one we discussed in our original letter, is their menu problem. The menu has become so bloated it now requires so many more moving parts to complete an order that the famous quick and efficient McDonald’s kitchen is now inefficient. As we pointed out in the letter, McDonald’s added over 9 items to its menu in 2013. McDonald’s now has 14 breakfast sandwich options and 16 burger options. One of the worst additions was the McWrap. Not only has it not sold well but when a McWrap is ordered it slows the whole kitchen down earning it the nickname “showstopper”. 5 items still drive 40% of McDonald’s sales and none of the major sellers are new items.

Now the CEO Don Thompson wants to add a design-your-own burger option that patrons can order via a touch screen. The idea is to compete more with restaurants like Chipotle (which McDonald’s used to own). This sounds good if most of your ordering was foot traffic like Chipotle but 70% of McDonald’s sales come from the drive-thru. Ordering via touch screen becomes problematic in the drive-thru and wait times go up. When drive-thru wait times go up the loyal customers who are used to and expecting quick service are driven away.

CEO Don Thompson is a great rags-to-riches story but it is clear he is not the right man to lead McDonald’s right now. The combination of an out of touch CEO, a highly profitable business, obvious shorter-term fixes, and hidden real estate value makes McDonald’s attractive for an activist investor. A company as large as McDonald’s used to be a deterrent for shareholder activism, the activist couldn’t build a meaningful stake to affect change, but now it’s not. In recent years several successful activist campaigns have been launched against very large companies like McDonald’s.

We said we would be buyers of McDonald’s if it fell below $100 per share and we did. Don’t be surprised if we make another round of purchases again soon.

Exelis (XLS) & Vectrus (VEC) from Volume 9 from June 28, 2014

Dividend Per Share Growth Since Write Up: 7.1%

Exelis spun off Vectrus, its mission systems business, as planned back in September. The new Exelis retained the higher margin and faster growing business divisions. The new Exelis also maintained its commitment to paying a dividend and even increased its quarterly payout post spin-off.

As for Vectrus, we usually like to hold onto the equity of spin-offs for at least a year to see if the new companies will become the dividend growers that we are looking. Spin-offs also tend to outperform the broad market for a few years after the spin-off event with most of the gains coming in the first year. So far with Vectrus this pattern has played out rising 40% in the first few months of its existence.

We are not making any new purchases in Exelis as we reevaluate its dividend growth potential post spin-off.

Gaming & Leisure Properties (GLPI) from Volume 10 from August 2, 2014

Dividend Per Share Growth Since Write Up: 0%

Two of the items we listed under the pre-mortem for Gaming and Leisure Properties were they are no longer the only gaming REIT (Real Estate Investment Trust) and a deal to buy Isle of Capri Casinos (ISLE) doesn’t materialize.

GLPI is still the only gaming focused REIT but it looks like it won’t be for long. Orange Capital successfully pushed through their plan to have Pinnacle Entertainment (PNK) spin-off their real estate assets into a REIT. Also, Caesar’s Entertainment (CZR) in an effort to restructure its heavy debt load and avoid a restructuring in bankruptcy announced that it wants to spin-off its real estate holdings as a REIT. More Gaming REITS equals more competition for deals. GLPI wants to pay around 9-13x EBITDA for any new assets. Deals at those multiples add value to GLPI. Deals at higher multiples destroy value. More REITS competing for deals can push the prices and multiples up to levels that are bad for GLPI and it would lead to GLPI paying too much or missing out on acquiring more properties.

The good news is before GLPI became a REIT its former parent Penn National Gaming (PENN) got IRS approval for the REIT and locked up a lease agreement between GLPI and PENN. Pinnacle Entertainment has not received IRS approval yet. The Caesar’s Entertainment REIT proposal is just that right now, a proposal. Caesar’s Debt holders have to agree to the restructuring and then Caesar’s Entertainment needs to get IRS approval too.

Isle of Capri deal chatter has slowed down from the summer. Deals usually don’t just happen because people start talking about them. They take time. Just look how long it took Reynold’s American to make a deal for Lorillard after rumors started floating; and those rumors were more substantiated.

Still we are monitoring GLPI for further erosion in our investment thesis. If we see more erosion we will likely sell our position in GLPI and look for better opportunities.

Visa (V) from Volume 11 from August 30, 2014

Dividend Per Share Growth Since Write Up: 20%

The catalysts we outlined a few months ago remain the same and nothing new has developed since then.

We will make further purchases on any short-term price weakness.

MasterCard (MA) from Volume 12 from October 4, 2014

Dividend Per Share Growth Since Write Up: 45%

The catalysts we outlined a few months ago remain the same and nothing new has developed except one item. MasterCard is initiating a new $3.75 Billion share repurchase program and they will increase the quarterly dividend by 45%.

We will make further purchases on any short-term price weakness.

Novartis (NVS) from Volume 13 from November 8, 2014

Dividend Per Share Growth Since Write Up: 0%

The catalysts we outlined a few months ago remain the same and nothing new has developed since then. The Wall Street Journal recently put out another article on using our own immune systems to help fight off cancer. Novartis’ Car T-Cell therapy was mentioned among others. You can read the article by following the link below.

Cancer’s Super-Survivors: How the Promise of Immunotherapy is Transforming Oncology

We will make further purchases on any short-term price weakness.

BlackRock (BLK) from Volume 14 from December 6, 2014

Dividend Per Share Growth Since Write Up: 0%

We will make further purchases on any short-term price weakness.

All previous AMM Dividend letters are archived here.

The opinions expressed in “The AMM Dividend Letter” are those of Gabriel Wisdom, Michael Moore and Glenn Busch and do not necessarily reflect the opinions of American Money Management, LLC (AMM), an SEC registered investment advisor who serves as a portfolio manager to private accounts as well as to mutual funds. Clients of AMM, Mr. Wisdom, Mr. Moore, Mr. Busch, employees of AMM, and mutual funds AMM manages may buy or sell investments mentioned without prior notice. This newsletter should not be considered investment advice and is for educational purposes only. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything. Current stock quotes are obtained at http://finance.yahoo.com. Prices are as of the close of the market on the date for which the price is referenced.

AMM Dividend Newsletter: Winning the Loser’s Game with Novartis (NVS)

This is from the AMM Dividend Letter released November 8, 2014. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing list here.

There are two types of tennis games. The game professionals play, a winner’s game, and the game Glenn plays with his friends on the weekend, a loser’s game.

Professionals playing a winner’s game have to win their points. A professional player’s opponent is equally as talented and shots need to be placed out of their opponent’s reach to win. When amateurs play tennis they are playing a loser’s game. Amateur tennis players are prone to double faulting, hitting the ball into the net, or hitting the ball out of bounds. Winning a point in a loser’s game is all about keeping the ball live and giving your opponent enough time to make the mistake.

  • Other loser’s games:
  • Golf – whoever makes the least mistakes usually wins
  • Politics – it’s about making voters not vote for your opponent rather than making people vote for you.
  • War – The side that makes the least amount of tactical and strategic errors usually wins.
  • The Stock Market

Investing in the stock market like a lot of things started out as a winner’s game. There was a time when a very smart, ambitious, and aggressive investor could win points against the rest of the crowd through many market inefficiencies. Now there are a lot of very smart, ambitious, and aggressive people working in the investment business competing away those inefficiencies. The stock market has shifted from a winner’s game to a loser’s game.

This is not to say you can’t win at investing; it means the strategy to succeed has shifted. The strategy is now like an amateur tennis game, reduce the unforced errors.

Reducing Unforced Errors in Investing

Charles Ellis in his essay The Loser’s Game highlights the strategy shift and the approach we take to daily portfolio management.

1) Reduce portfolio turnover. The highly liquid nature of the stock market may look like an asset but it can be a huge liability. It is far too tempting and easy given the immediate liquidity to sell stocks when things look scary. On top of the extra drag from increased commissions and fees, selling creates another problem, when to buy back in? Instead of having to make one right decision, selling, you have to make two correct decisions, selling and buying. The 15 year performance study of 81 “professional” stock-market timers by Hulbert Financial Digest shows this is an extremely difficult task.

Just 11 of 81 stock-market timers—those advisers who try to predict when to get into or out of the market to sidestep declines and participate in rallies—actually made money during the bear market that began after the Internet bubble burst in March 2000 and ended in October 2002.

These market timers have lost so much since then that, on average, they are in the red over the entire period since March 2000, having chalked up a 0.8% annualized loss.

2) Keep it simple. From the book Extraordinary Tennis Ordinary Players by Simon Ramo, “Every game boils down to doing the things you do best, and doing them over and over again”. We’re focused on buying high-quality, highly profitable, and high cash flow generating businesses that pay a dividend and grow their dividend at a compound annual rate far above the rate of inflation.

3) Avoiding portfolio pitfalls. Most investors focus on what to buy and most research out there is designed to help them do just that. However, more time should be spent on what to sell. The biggest risk to a portfolio is already in there. Eliminating future problems provides far more benefits in the long run then not buying a specific stock.

Following this strategy does not mean we will not make errors, we will. Errors are unavoidable. Reducing and avoiding errors as much as possible leaves behind a series of small portfolio successes. These small successes compounded over time lead to long-term portfolio gains.

Dividend Stock in Focus

Novartis AG (NVS): $91.76*
*price as of the close November 7, 2014

Novartis is a Switzerland based diversified pharmaceutical company. It operates in branded pharmaceuticals, generic pharmaceuticals (Sandoz division), eye-care (Alcon division), consumer health, and vaccines. The overwhelming majority of Novartis’ revenue and profits, 55% and 85% respectively, comes from its branded pharmaceuticals. Novartis’ revenue sources are broken down further in the chart below.

From S&P Capital IQ. Click to enlarge.
From S&P Capital IQ. Click to enlarge.

Because branded pharmaceuticals drive so much of Novartis’ revenue and profits we will highlight two of their drugs below. The first drug is one of Novartis’ top late stage drugs that will drive near term revenues and profitability. The other is an option on the future and a potential breakthrough in cancer treatment.

Dividend History:

Over the last 9 years Novartis has grown its dividend at a compound annual rate of 11.77%.

From S&P Capital IQ. Click to enlarge.
From S&P Capital IQ. Click to enlarge.

Catalysts for Dividend Growth and Price Appreciation:

Heart Failure & LCZ696

Heart failure is essentially the inability of the heart to pump an adequate amount of blood to meet the demands of all the body’s organ systems. Heart failure is the end stage of a culmination of several cardiac diseases like chronic hypertension, coronary artery disease, cardiomyopathy (damage to heart muscle), and other diseases like diabetes and emphysema. A large problem with heart failure is the lack of blood flow causes the kidneys to turn on a hormone system known as RAAS (Renin-Angiotensin-Aldosterone System). The RAAS system tells the body to hold onto sodium and water in an effort to increase blood flow but this is not a good thing during heart failure. The excess blood volume causes the heart to pump less well.

The standard treatment for heart failure is counteracting the RAAS hormone system with either Angiotensin-Converting Enzyme Inhibitors (ACEIs) or Angiotensin Receptor Blockers (ARBs). The use of either two has shown to reduce heart failure mortality by 16%.

The body during heart failure actually releases natriuretic peptides that tell the kidneys to stop holding on to water and salt through the RAAS system. The problem is the Neprilysin enzyme. During heart failure there is so much of this enzyme floating around that it shuts down the natriuretic peptides. In theory a novel drug that did the same work as the Angiotensin-Converting Enzyme Inhibitors (ACEIs) or Agiotensin Receptor Blockers (ARBs) and blocked the effects of Neprilysin would reduce heart failure mortality rates even more.

Enter Novartis’ LCZ696.

The charts below are from a recent study comparing the effectiveness of LCZ696 (redline) versus Enalapril (black line), an Angiotensin-Converting Enzyme Inhibitor, for patients with systolic heart failure (left side of the heart can’t pump blood effectively).

Chart from The New England journal of Medicine: Angiotensin-Neprilysin Inhibition versus Enalapril in Heart Failure
Chart from The New England journal of Medicine: Angiotensin-Neprilysin Inhibition versus Enalapril in Heart Failure. Click to enlarge.

Essentially the study shows that LCZ696 is significantly more effective in reducing the risk of death and hospitalization from heart failure than the current method of using an ACEI by itself. The study doesn’t argue for an add-on of LCZ696 to the current method for treating heart failure, it can’t because of the risks of other complications. Rather the study supports the argument that LCZ696 should replace ACEIs and ARBs.

LCZ696 can’t replace ACEIs and ARBS completely because of physician resistance and some patients’ inability to tolerate the medicine. However, given the current prevalence of heart failure in the U.S. and expected U.S. and global growth this creates a huge market opportunity for Novartis and LCZ696 in replacing ACEIs and ARBs.

Chart courtesy of Circulation
Chart courtesy of Circulation. Click to enlarge.

In the most recent earnings call management said they see sales in the $2-5 billion range while analysts are predicting sales in the $8-10 billion range. Management tends to under promise and analysts tend to be too optimistic. The real range probably lies in the $5-8 billion range.

Novartis is expecting to submit LCZ696 to the FDA by year-end and obtain a decision by the end of 2015.

Car T Cell therapy

22 children with acute lymphoblastic leukemia, the most common childhood cancer, were out of luck. They had exhausted all current drug treatments and bone-marrow transplant options. Their very last option was to sign up for the experimental trial of Novartis’ latest cancer treatment.

The results?

90% of them saw their leukemia enter into remission.

The treatment is called CAR T-Cell therapy. It is the body using its own immune system to detect cancer cells and destroy them in a highly targeted attack.

Image courtesy of The Wall Street Journal. Click to enlarge.
Image courtesy of The Wall Street Journal. Click to enlarge.

The market potential for this new type of therapy has been estimated as high as $35 billion and upwards of $10 billion in sales per year for Novartis’ leukemia treatment CTL019 (CART-19) alone.

With high rewards come high risks. Right now the therapy isn’t easy to produce and even harder to mass produce a personalized cell-based treatment. A mistake in the “reprogramming” of the T-cells and their reintroduction into the patient’s body can lead to a deadly side affect, cytokine release syndrome or more ominously known as a Cytokine Storm. Then there is always competition from other pharmaceutical companies. If the efficacy from this first small trial holds up in upcoming larger trials and if Novartis can overcome the manufacturing hurdles then the market potential for these new cancer treatments is huge.

Our investment in Novartis is not dependent on the success of CAR T-Cell therapy. We believe we are buying a very cheap call option on the market potential of CAR T-Cell therapy wrapped around a large diversified pharmaceutical company.

Pre-Mortem:

Lateg Stage Pipeline Can’t Replace the Patent Cliff

Each and every large pharmaceutical company is facing a loss of patents on many of their top selling drugs, Novartis is no different. However, Novartis’ late stage drug pipeline is considered to be one of the best, relative to other large pharmaceutical companies. LCZ696 is one of the late stage drugs that makes Novartis’ late stage pipeline so attractive. However, no matter how attractive their pipeline these drugs are not blockbusters yet nor have they even been approved by the FDA.

Diovan Patent Loss

Diovan is an Angiotensin Receptor Blocker (ARB) mentioned above and it also accounts for about 10% of Novartis’ total sales. Diovan is a part of the “patent cliff” facing Novartis; the drug came off patent in 2013. Generic competition will take market share away from Novartis and eat away at Novartis’ sales. This is why LCZ696 is crucial to Novartis growing future sales.

Efficacy & Cost Effectiveness

The blockbuster status of LCZ696 will come down to a couple questions. Is the drug truly more effective than current heart failure treatment? The most recent data says yes but again this was a done in part by Novartis. If further data shows otherwise then future sales of LCZ696 will be affected.

The second question is what is the correct pricing for the drug to get maximum conversion for heart failure treatment while still garnering a premium price? If the drug is priced too high above generic ACEIs and ARBs, even given the higher efficacy of LCZ696, Novartis may hurt the adoption rate and sales of LCZ696.

Conclusion:

Novartis has been a holding in portfolios since late 2011. We have held off on making any new purchases for newer accounts as the stock consistently traded above our estimate of fair value, albeit by a small margin. So why did we finally make a new purchase after the company hit another new high? Our valuation changed with the release of LCZ696’s latest data. Novartis’ late stage pipeline became more valuable and we adjusted our estimate of fair value upward to $100 per share. In hindsight, as you can see in the chart below, if we had waited a few weeks we would’ve had a much better opportunity to buy Novartis. We can’t control the future. We can only focus on our valuations and our process and based on both Novartis became a buy again.

Price is what you pay and value is what you get. – Warren Buffett

Chart courtesy of Stockcharts.com. Click to enlarge.
Chart courtesy of Stockcharts.com. Click to enlarge.
The opinions expressed in “The AMM Dividend Letter” are those of Gabriel Wisdom, Michael Moore and Glenn Busch and do not necessarily reflect the opinions of American Money Management, LLC (AMM), an SEC registered investment advisor who serves as a portfolio manager to private accounts as well as to mutual funds. Clients of AMM, Mr. Wisdom, Mr. Moore, Mr. Busch, employees of AMM, and mutual funds AMM manages may buy or sell investments mentioned without prior notice. This newsletter should not be considered investment advice and is for educational purposes only. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything. Current stock quotes are obtained at http://finance.yahoo.com. Prices are as of the close of the market on the date for which the price is referenced.