STOCK OF THE MONTH SALLIE MAE MOVES TO THE HEAD OF THE CLASS WITH STRAIGHT A'S
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(MONEY Magazine) – Lending money to needy college students may not sound like an easy way to make big profits, but the Student Loan Marketing Association -- Sallie Mae, for short -- has prospered at it. During the past five years, the Washington, D.C. company has provided $23 billion for 9 million student loans, and its earnings have grown at a phenomenal average rate of 56%. Because of the government mandate under which Sallie Mae operates, it enjoys distinct advantages over other lending institutions. First, most of the loans on Sallie Mae's books are virtually risk-free; they are either guaranteed by the federal government or indirectly backed by some form of government security, such as Treasury bonds. Second, Sallie Mae is largely insulated from the effects of fluctuating interest rates. The government subsidizes yields on student loans, which have been set 3 1/2 percentage points above the rate on Treasury bills. Since Sallie Mae can borrow from investors at about half a percentage point above the T-bill rate, the company is assured of a profit on existing loans of about 3% before corporate overhead.

Last October, in reauthorizing the Guaranteed Student Loan Program until 1991, Congress was extremely favorable to Sallie Mae, though it tightened its provisions a bit -- cutting the subsidy for new loans from 3 1/2 points to 3 1/4, for instance. ''The real danger was that Congress would drastically reduce the subsidy or limit the growth of new loans,'' says Ram Capoor, an analyst at Morgan Stanley. That didn't happen. Instead, the new law permits eligible students to borrow more -- a maximum for undergraduates of $2,625 to $4,000 a year, up from $2,500. This higher limit will more than compensate Sallie Mae for the shrinking student population. During the next five years, analysts expect that Sallie Mae's earnings per share will increase on average at 20% a year. The stock recently traded on the New York Stock Exchange at $65, giving it a moderate P/E ratio of 15.7 based on estimated earnings of $4.15 a share for 1987, up from $3.10 in 1986. Capoor considers the stock attractive for conservative investors and believes it could reach $85 within the next 12 months. Sallie Mae should also appeal to aggressive investors because of a recently issued warrant, says Barry Cohen, warrant analyst at First Boston. Warrants are similar to options and move up and down in price much faster than the stock to which they are related. The Sallie Mae warrant gives the owner the right to buy one share of the common stock for $100 at any time within the next five years. If the stock rose 30% to $85 during the next six months, Cohen calculates that the warrant, currently trading over the counter at $9, would double in price.