T. Rowe Price Group, Inc. is a publicly owned investment manager. The company was founded in 1937 and manages money for individual through mutual funds along with providing advice to institutional investors. It has a wide lineup of investment selections and is among the most well known mutual fund companies in the United States. My positive investment thesis for T. Rowe Price Group is based upon seven key criteria, which include:
Key Selection Criteria
- Large market capitalization.
- A leadership position within a industry.
- A strong balance sheet & solid cash flow.
- A dividend above that of the S&P 500.
- A strong commitment to dividend growth.
- A strong balance sheet & high credit rating.
- A low historical relative valuation as measured by price/sales and/or price/earnings ratios.
T. Rowe Price (SYMBOL: TROW) is a large-cap financial services firm with a current market capitalization of $16.07B. It is one of the largest mutual fund and 401k providers in the United States. Its primary channels for sales is through individual investors in IRAs, Roth IRAs, and 401k plans. It also serves institutional investors.
TROW maintains a leadership position in the mutual fund industry. It currently ranks 13th in the world in assets under management. Assets under management increased $13.5 billion in the first half of 2016. TROW now manages $776.6 billion as of the end of June 2016.
Balance Sheet, Credit Rating, & Cash Holdings
The balance sheet of the company is in excellent condition. TROW maintains a credit rating of A+ from Standard & Poor's Ratings Services. Return on equity remains stellar at nearly 25%. T. Rowe Price remains debt-free. Its cash through its discretionary portfolio investment holdings amount to $2.1 billion as of the end of June 2016.
Relative Valuation Analysis & Price Projection
As for relative valuation, I have a preference for price/sales ratio over price/book when examining the merits of a company in the financial services - investment management industry. TROW has traded at a price/sales ratio range of 2.77 to 8.51 in the last decade. The average price/sales ratio for the last ten years, including 2008, has been 5.5.
Target Price 2021 = $101.74
Net Revenue Per Share
Table 1 Data Source; T. Rowe Price Annual Report
At a price of $65.20, TROW stock currently trades at a price/sales ratio 3.8. To predict a price of TROW utilizing relative valuation analysis, I assume that net revenue per share for TROW to conservatively grow at 5% through the year of 2021. This assumes a more modest growth rate in assets along with a slight improvement in stock and bond markets (leads to higher fees collected). This is below the growth rate of revenue growth than in the past five years (13%). This places net revenue per share at 21.88 by 2021. I do consider buybacks in the analysis. Buybacks should continue on its current pace and will also enhance the reduction of share count. Earlier this year the Board of Directors of the firm authorized an additional buyback authorization of 12 million shares. Combined with previous authorized buyback provisions, TROW now has the capability to re-purchase nearly 21 million shares of stock.
I expect TROW can trade at a modest price/sales ratio of 4.65 in 2021 given its lower growth profile. This expected price/sales ratio is below the historical average of 5.5. If TROW can generate my assumed conservative net revenue per share of 21.88 and can trade at a multiple of 4.65 in 2021, my expected price target for the stock would be $101.74.
Dividends & Cumulative Return Projection
TROW has a long history of paying and increasing dividends. In the last annual shareholder meeting, the Board of Directors increased the regular annual dividend for the 29th time. The firm remains an above-average dividend payer in the financial sector. It also pays out less than 50% of its earnings in dividends. This will allow TROW to further enhance its dividend through 2021 even in difficult capital markets. Dividends have escalated from $1.24 in 2011 to $2.08 a share today, an annual growth rate of nearly 12%. The current dividend yield stands at an attractive 3.5%. Although I expect TROW to not match its pace of dividend hikes in the past half decade, I believe the firm can deliver a less robust 7.2% dividend growth rate in the next five years. With an assumed 7.2% growth rate, TROW should pay the following yearly dividends out to 2021.
|$2.08 - 2017|
|$2.39 - 2019|
|$2.56 - 2020|
|$2.74 - 2021|
Table 2 Data Source; T. Rowe Price Annual Report
Add the total dividends collected ($12) to my target price ($101.74) an investor who purchased TROW today would potentially earn a dollar return on investment of $48.54 ($113.74) - ($65.20). This results in a cumulative return of 74.44%. This assumption does not account for the reinvestment of dividends over time. This critical issue is discussed further in the analysis section below.
T Rowe Price Dividend Payout History - 5 Years
Dividends Per Share
Tables 3 Data Source: T. Rowe Price Annual Report 2015
The primary risk element for T. Rowe Price at the moment is the altering asset management industry and the movement toward ETFs. The fund company that has over $775 billion in assets has shied away from passive management and ETFs for years. This has been primarily due to the disclose requirements by regulators on ETFs. Traditional ETFs must disclose their holdings on a daily basis. By opting out, T. Rowe Price faces threats from the burgeoning industry. According to Factset, U.S. investors placed $65 billion in assets into ETFs this year through June and through April there is $2.2 trillion of assets in U.S. listed ETFs. There are now nearly 6250 ETFs available for global investors. The attraction is the low cost indexing approach along with the new focus on factor investing. Factor investing has been behind much of the ETF growth in the last three years. Also known as smart beta investing, these ETFs utilize specific factors (i.e. low volatility, value, momentum) to gain an edge and potentially provide investors with above market returns. BlackRock (NYSE:BLK) has projected that factor ETFs will continue to garner assets at a high pace and ultimately reach $1 trillion in global assets within 4 years. This would be four times the amount that are in smart beta ETFs today. The fact is that traditional index ETFs are not gaining assets as fast as the smart beta, which attempt to outperform the market much like active based funds. This could be a relief for TROW. In the future TROW will be better suited to compete against ETFs as smart beta products are nearly "active management" clones. The company initiated the process with regulators to sell ETFs that do not disclose holdings in 2013. These are known as "non-transparent" ETFs, which would grant TROW access into the ETF business while still utilizing their active management capabilities.
Unfortunately, the "non-transparent" allowance has been slow to come. But the market expects that by the end of 2017, these ETFs will likely come on to the major exchanges. This would allow TROW to better compete against BlackRock and other major ETF providers in the future. And, TROW is moving in the direction of not just traditional stock picking, but also quantitative investing. The firm recently released three quantitative funds into the lineup. These include the QM U.S. Small & Mid-Cap Core Equity Fund (MUTF:TQSMX), the QM U.S. Value Equity Fund (MUTF:TQMVX), and the QM Global Equity Fund (MUTF:TQGEX). There is large opportunity for TROW to gather assets in this quantitative asset class. This year $13.7 billion flowed into quant funds, the highest of any major investment category. Additionally, when the new ETFs become available (most likely next year), TROW has the opportunity to also offer these quantum investing capabilities into ETF vehicles and enhance offerings. Other opportunities for growth at TROW are in the international area, where less than 10% of their assets come from. Organic growth will most likely come from its strong position in target-date retirement funds.
Despite the explosion in ETFs over the last decade, TROW has remained best of class among the traditional mutual fund companies. The firm has a very loyal group of investors that have been consistently rewarded with solid performance. According to the company, over 75% of their funds for individual investors have expense ratios below their peer category averages. And of the 18 largest U.S. equity funds within their universe of selections, 13 of the 18 funds had outperformed the designated benchmark in a 3-year period. Over the longer term horizon, the results of TROW funds is also strong. Over 16 of 18 funds have outperformed over 5-year periods and 15 funds were ahead over 10-year intervals. Another element to TROW's attractiveness as a more defensive asset management company is that two thirds of assets are held in retirement accounts and variable-annuity investment portfolios. Thus TROW has a more stable asset management portfolio than many other firms within the industry. There is also further growth potential in this area. Assets in TROW's target-date retirement portfolios have now reached $178 billion, an increase of 30% from 2013.
Conclusion & Dividend Projections
With the advantage of TROW's leading mutual fund retirement platforms, exceptional balance sheet, top-performing mutual funds, and active ETF potential, I feel an investment in T. Rowe Price stock should be strongly considered at the present price of $65.20. Although I believe that capital gain appreciation is a strong possibility given its relative low valuation, the high and growing dividend also makes TROW a very attractive investment candidate.
I invariably contemplate what an investment in any dividend paying company would be without price appreciation. This is due to the fact that the stock market and/or sectors go through elongated periods of sideways price action. Additionally, in my assumptions, I am projecting continued revenue growth, perpetual buybacks, and a slight upward progression in price/sales ratio, which are by no means guaranteed outcomes.
A key advantage of becoming a shareholder of TROW versus other firms is its high level of dividend payments and the firm's consistent rate of dividend growth. For an example of how the compounding effects of dividend reinvestment work, examine TROW in the table below. I assume that an investor would buy TROW at its current price of $65.20 and there would be NO price appreciation over the ensuing decade;
|DATE||SHARES HELD||DIVIDEND||PRICE TROW||PAYOUT||REPURCHASED SHARES||CASH REMAINDER|
An investor starting with a $10,000 investment in TROW price today could purchase 153 shares, with remaining cash of $4.48. If the price held steady for the next 12 months, the investor could purchase an additional 5 shares of stock just from the dividends collected ($330.48). Each subsequent year, TROW's dividend would continue to grow (based upon historical precedent) along with the shares owned. By the end of the ten year period, our TROW investor would have repurchased 72 shares of additional stock and the investor's shares would now payout nearly $900 in annual dividends.
Total portfolio worth of this investment would have climbed from $10,000 to $14,625, simply through dividend collection and reinvestment. This table demonstrates the power of dividend growth investing and should give any investor in TROW the confidence that his or her dollars will be earning a return even if the stock market struggles to advance over the next decade.
Disclosure: I am/we are long TROW.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.