Seeking Alpha
Deep value, long-term horizon, dividend growth investing, portfolio strategy
Profile| Send Message|
( followers)  

T. Rowe Price Group Inc. (NASDAQ:TROW) is a financial services holding company. It provides investment advisory services to individual and institutional investors in the sponsored T. Rowe Price mutual funds and other investment portfolios. T Rowe Price Group is a dividend aristocrat that has raised its dividend for 24 consecutive years.

A 10-year summary of Sales, Earnings Before Interest and Tax (EBIT), Earnings per share (EPS), yearly high and low stock price, corresponding high and low P/E (calculated by dividing the high and low price by the EPS for the year), and average P/E (average of high and low P/E) is shown below.

Key 10-year data for T. Rowe Price

Year Sales (in Millions) EBIT (in Millions) EPS High Price Low Price High P/E Low P/E Average P/E
2010 2364.3 1070 2.53 64.7 43.6 25.6 17.2 21.4
2009 1864.9 688.9 1.65 54.3 21 32.9 12.7 22.8
2008 2114.9 796.2 1.81 65 27.8 35.9 15.4 25.6
2007 2227.2 1076.8 2.4 64.7 43.7 27.0 18.2 22.6
2006 1813.9 858.3 1.9 47.8 35.4 25.2 18.6 21.9
2005 1511.54 679.39 1.58 37.3 27.5 23.6 17.4 20.5
2004 1276.57 533.78 1.26 31.4 22.3 24.9 17.7 21.3
2003 994.95 365.52 0.89 22.9 12.9 25.7 14.5 20.1
2002 922.77 309.6 0.76 20.7 11.5 27.2 15.1 21.2
2001 994.92 330.59 0.76 21.1 12.8 27.8 16.8 22.3

From these data, we can plot Sales, EBIT, and EPS versus Year, as shown in the chart below.

Sales (in Millions), EBIT (in Millions), and EPS versus Year for T. Rowe Price, 2001-2010

As evident from the above chart, TROW has demonstrated reasonably predictable sales and earnings over the past 10 years (with a dip in 2008-2009 due to the financial crisis), allowing us to predict EPS in the near future, say in five years (i.e. Year 2016), using the linear regression equation for EPS = 0.1848 (2016) - 369.16 = 3.3968.

A conservative average P/E estimate for the stock can be obtained as follows:

Signature P/E: A well established stock has a signature P/E, an average P/E it commands in the market based on its business. We calculate this by averaging the Average P/E over the past 10 years, excluding any outliers (values that fall significantly beyond the other data points). There are no outliers, so we average the Average P/Es from all ten previous years to arrive at a signature P/E of 22.

High P/E estimate: a conservative high P/E estimate can be calculated by averaging the five lowest High P/Es of the 10 High P/Es from the past 10 years. The 5 lowest High P/Es from the past 10 years are 23.6, 24.9, 25.2, 25.6, and 25.7, which average 25.

Low P/E estimate: a conservative low P/E estimate can be calculated by averaging the five lowest Low P/Es of the 10 High P/Es from the past 10 years. The 5 lowest Low P/Es from the past 10 years are 12.7, 14.5, 15.1, 15.4, and 16.8, which average 14.9.

Average P/E estimate: this takes the average of the High P/E estimate and the Low P/E estimate, as calculated above, to give a conservative estimate of an average P/E for the stock we can expect. Averaging 25 and 14.9 gives us 20.

Multiplying our EPS projection for 5 years hence by the average P/E estimate gives us a projected average price for the stock: $3.3968 * 20 = $67.78. Compared with the current price of $59.33, this represents an annual stock price return = 3.4%. When we add in the 2.1% dividend yield, the total return expected is an annualized 5.5%, which means an investment in TROW today is expected to double in about 13 years.

Given a beta = 1.62 for TROW, a risk-free rate = 3% (using the yield on 10-year Treasury bond as a benchmark), and estimated risk premium of about 5% for the general stock market, we have a discount rate = 3% + 1.62*(5%) = 11.1%. Applying this discount rate of 11.1%, our projected price of $67.78 in 5 years translates to a target price = $40 in today's dollars, which is about 33% below the current price of $59.33 for the stock. For a good margin of safety, investors are well advised to buy only if the current price is at least 20% below the target price. Since the current price is above our target price, this stock is not a buy right now. It is also not a sell, however, because it is still expected to return 5.5% per year over the next 5 years. A pullback to $32 (not impossible, as the stock fell to $21 in 2009 during the financial crisis) would provide long term investors enough margin of safety to buy the stock.

What is the market's expectation of TROW's growth rate given its current market price = $59.33? Since stock price = dividend * (1 + growth rate) / (discount rate - growth rate), plugging in stock price = $59.33, dividend rate = $1.24, and discount rate = 11.1%, and solving for the growth rate, we get 8.8%. This is probably reasonable, given that TROW has grown its revenue by 9.4% annually, its earnings by 9.2% annually, and its dividend by 17% annually over the past 5 years. The growth rate is supposed to slow down a bit as a company matures, so 8.8% growth seems reasonable. A target price of $32 would imply a 7% growth rate expectation, while a projected price of $67.78 in five years, if reached today, would imply a 9.1% growth rate expectation.

As an additional consideration, we should also determine how the stock's current P/E compares with its signature P/E, since established stocks tend to revert back to their respective signature P/Es over the long term. Current EPS = 2.91, giving us a current P/E = 20.4. This is 93% of the stock's signature P/E of 22, which suggests the stock is currently fairly valued. In general, we should look to buy when the current P/E is 80% or less of the stock's signature P/E. For TROW, that means a price target of $51.

Lastly, we calculate the Risk Index, calculated as (Current Price - Forecast Low Price)/ (Potential High Price - Forecast Low Price) to give an estimate of the risk: reward ratio. Risk index less than 20% is desired, which gives us +200% potential returns for every risk of 50% loss we assume.

The Forecast Low Price is calculated by multiplying the Low P/E estimate by the Forecast Low EPS, to give a conservative estimate of low price for the stock in 5 years, assuming zero EPS growth and low valuation. Forecast Low EPS is estimated by averaging the EPS over the past 5 years. For growth stocks with predictable earnings growth, EPS in 5 years should not be any lower than this conservative estimate. For TROW, the forecast low EPS is equal to 2.058, so the Forecast Low Price = 14.9 * 2.058 = $30.69.

The Potential High Price is calculated by multiplying the High P/E estimate by the projected EPS in 5 years, giving us a price target in 5 years should the stock command a high P/E. For TROW, this equals 25 * 3.3968 = $84.91.

Thus, the Risk Index = ($59.33 - $30.69) / ($84.91 - $30.69) = 53%. Since this is significantly above 20%, we have an unfavorable reward to risk ratio at the current price. Again, this argues against a Buy at the current price.

Conclusion

T. Rowe Price Group, currently selling at $59.33, has a target price = $40. Its current P/E of 20.4 is about the same as the stock's historic P/E average of 22, and its downside risk outweighs its upside potential. Despite these negatives, the stock is still expected to deliver 5.5% annually over the next 5 years. Therefore, I rate the stock a Hold at the current price. I recommend buying on a pullback to $32, if the fundamentals remain intact.

Disclaimer: Use this information as a starting point for your own due diligence, before buying any stock. If you do buy, be sure to read any annual reports (10-K) and quarterly reports (10-Q) to ensure that the fundamentals remain good and the stock is on target to reach its projected price. After holding for five years, repeat the analysis detailed in the article to decide whether to continue to hold, add, or reduce your position.

Source: T. Rowe A 'Hold' At Current Levels