Published by Bob Ciura on October 15th, 2017
Investors looking for high-quality dividend growth stocks, should look first and foremost at the Dividend Aristocrats. The Aristocrats are an exclusive list of 51 stocks in the S&P 500 Index, with 25+ years of consecutive dividend increases.
T. Rowe Price (TROW) is on the list, and is one of just five Dividend Aristocrats from the financial sector. It has increased its dividend for 31 years in a row, including a 5.6% hike on February 16th.
T. Rowe Price has a strong brand, a highly profitable business, and future growth potential.
The stock has a 2.7% dividend yield, which is above the 2.1% average dividend yield of the S&P 500 Index. And, the stock also has a lower valuation than the S&P 500, meaning it could be undervalued as well.
Add it all up, and T. Rowe Price has many of the qualities dividend growth investors typically look for.
Business Overview
T. Rowe Price was founded in 1937 by Thomas Rowe Price, Jr. In the eight decades since, T. Rowe Price has grown into one of the largest financial services providers in the U.S.
Today, the company has a market cap of $22.8 billion and manages over $900 billion in assets.
The company provides mutual funds, advisory services, and separately managed accounts for individuals, institutional investors, retirement plans, and financial intermediaries.
T. Rowe Price has a diverse client base, in terms of assets and client type.
Source: 2017 Investor Day, page 6
2016 was a year characterized by uncertainty. The U.S. elections, the aftermath of the Brexit vote in Europe, and slowing economic growth in China all contributed to elevated levels of uncertainty.
And yet, T. Rowe Price performed well. Assets under management increased 6% over the course of 2016, ending the year at $811 billion. This drove 0.5% revenue growth, to $4.2 billion for the year.
Diluted earnings-per-share increased 2.6% for the year, to $4.75. There should be room for T. Rowe Price to continue increasing earnings moving forward.
Growth Prospects
T. Rowe Price has a number of catalysts for future growth. The first catalyst is higher assets under management. The company has done very well this year, in attracting investor capital.
T. Rowe Price ended September with $948 billion in assets under management. AUM has increased 17% since the end of 2016. This is excellent growth, and will help drive higher revenue through investment fees.
This has already started to occur. The company has seen much stronger growth rates so far in 2017, than last year. For example, net revenue increased 12% over the first two quarters of 2017, thanks to 14% growth in advisory fees.
Specifically, T. Rowe Price has benefited from the flow of investor capital away from actively-managed products, toward passive investments.
Source: 2017 Annual Stockholder Meeting, page 9
Expense controls will also help boost earnings growth. Operating expenses increased at a lower rate than revenue to start 2017, which helps support margins.
Lastly, share repurchases are a part of the company’s earnings growth plan. T. Rowe Price repurchased 10 million of its own shares in 2016, representing a 4% decline in diluted shares outstanding for the year. The company further reduced its share count by 3% over the first half of 2017.
Overall, adjusted earnings-per-share increased 16% in the first half.
Competitive Advantages & Recession Performance
T. Rowe Price’s competitive advantage comes from its brand recognition and expertise. The company enjoys a good reputation in the financial services industry. This helps generate fees, a major driver of revenue.
It has built this reputation through strong mutual fund performance. According to T. Rowe Price, 84% of its funds outperformed their Lipper averages in the past three years.
Source: 2017 Annual Stockholder Meeting, page 6
Over five and 10 years, T. Rowe Price had 80% and 86% of mutual funds outperform the Lipper averages, respectively.
T. Rowe Price considers its employees to be its most valuable assets. There is good reason for this, since it is critical for an asset management company to have qualified experts and retain top talent.
This focus on building a strong brand gives the company competitive advantages, primarily the ability to keep existing clients, and bring in new ones.
T. Rowe Price did not perform well during the Great Recession:
- 2007 earnings-per-share of $2.40
- 2008 earnings-per-share of $1.82 (24% decline)
- 2009 earnings-per-share of $1.65 (9% decline)
- 2010 earnings-per-share of $2.53 (53% increase)
- 2011 earnings-per-share of $2.92 (15% increase)
As could be expected, T. Rowe Price experienced a sharp decline in earnings-per-share in 2008 and 2009. When stock markets decline, equity investors typically withdraw funds to raise cash.
Fortunately, the company remained profitable throughout the recession, which allowed it to continue raising its dividend each year. And, T. Rowe Price quickly recovered in the aftermath of the Great Recession. Earnings increased significantly in 2010, and by 2011 had reached a new high.
Valuation & Expected Returns
In the past four reported quarters, T. Rowe Price generated adjusted earnings-per-share of $4.84. As a result, the stock has a trailing price-to-earnings ratio of 19.6. This is a lower valuation than the S&P 500 Index, which has an average price-to-earnings ratio of 25.5.
For a company with a strong brand, consistent profitability, and earnings growth, T. Rowe Price stock seems to be undervalued.
An expanding price-to-earnings ratio would fuel substantial returns, as will earnings growth and dividends.
According to ValueLine, analysts expect T. Rowe Price to grow earnings-per-share by 21% in 2017. Earnings growth is expected to slow considerably in 2018, to 3%.
Over the long-term, earnings growth in the high-single digits seems realistic and attainable for T. Rowe Price. If that proves accurate, a potential breakdown of future returns is as follows:
- 3%-5% revenue growth
- 1% margin expansion
- 3%-4% share repurchases
- 2.4% dividend yield
From this, future returns would reach approximately 9%-13% per year, including dividends.
Final Thoughts
Investors scanning the financial sector for dividend stocks may naturally land on the big banks. But there are no bank stocks on the list of Dividend Aristocrats.
In fact, the only Dividend Aristocrats hailing from the financial sector, come from the insurance and investment management industry. This speaks volumes about the stability of their business models.
T. Rowe Price is an industry leader, and should continue to increase its dividend each year
