In part 22 of my 54 part Dividend Aristocrats In Focus series I take a look at the operations, growth prospects, and competitive advantage of asset manager T. Rowe Price Group (TROW). The company was founded in 1954 and has grown to $738 billion in assets under management. The company provides retirement plans, mutual funds, separately managed accounts, and a broad array of other financial and investment services. T. Rowe has increased its dividend payments to shareholders for 27 consecutive years. It is the only other asset management Dividend Aristocrat besides competitor Franklin Resources (BEN).
T. Rowe’s competitive advantage comes from its trusted name in the mutual fund industry. The company generates the bulk of its revenue from its mutual funds. As a result, outperformance compared to its peers is critical for the company to continue marketing its mutual funds. The company has outperformed its peers based on Lipper mutual fund averages. The percentage of the company’s mutual funds that have outperformed over various time frames is shown below:
- 1 Year: 71%
- 3 Year: 76%
- 5 Year: 77%
- 10 Year: 82%
The company’s competitive mutual fund products have helped it reach its massive scale. T. Rowe has a weaker competitive advantage than many of the other dividend aristocrats I have examined. As is repeated ad nauseam to investors, “past performance is no guarantee of future results”. Just because T. Rowe has outperformed its peers over the last decade, does not necessarily mean it can keep pace indefinitely. If the company begins to slip, I would expect significant client outflows of money from its mutual funds.
Future Growth Prospects
Rowe’s growth is driven by rising global markets and increasing its share of the asset management industry by attracting new clients to its funds. The company has benefited greatly from the 5 year bull market we find ourselves in. As asset values increase, the fund has a larger asset under management base with which to charge fees. Of course, when markets correct, T. Rowe’s asset base will shrink, along with its fees, revenues, and earnings per share.
The company’s recent growth has been less than stellar when you account for the five year bull market. The company’s full year 2013 marked the first time since 2001 when net cash flows into the company’s various investment products and services was negative. There is no good reason for this other than the company is slowly losing ground. Total cash flows were negative again for the company’s most recent second quarter 2014.
The financial landscape is trending toward ETFs and low fee options. Companies like Vanguard Group have experienced strong growth over the last decade benefitting from this trend. I don’t believe T. Rowe price is going out of business any time soon, but I don’t see a durable competitive advantage that differentiates it from its competition or protects it from the low fee trend in investing. With flat to negative cash flows and assuming long-term after inflation global market growth of 7% (which is generous), I can see T. Rowe growing EPS by 3% to 7% a year going forward, with the potential to do significantly worse over the next several years if a bear market reduces asset values.
Rowe currently has a dividend yield of 2.3% and a payout ratio of about 37%. The company has increased its dividend payments for 27 consecutive years. With its above-average dividend yield and fairly low payout ratio, T. Rowe price has room to raise its dividend above overall company growth for several years.
Based on the overvalued nature of the market today and the higher likelihood of a recession, I believe T. Rowe’s management will not grow its dividend payments faster than overall company growth even though it has the ability to do so. As a result, I would expect dividend growth significantly slower than the double-digit dividned per share growth the company has seen in the last decade.
Rowe saw earnings and revenue fall during the Great Recession of 2007 to 2009. To the company’s credit, earnings per share remained positive throughout the recession. The company quickly rebounded, and reached new highs in earnings per share by 2010. The company’s revenue per share and earnings per share throughout the most recent recession and through the first year of recovery are listed below to give you a better idea of the company’s performance through that time.
- 2007 EPS of $2.40, revenue per share of $8.42
- 2008 EPS of $1.82, revenue per share of $8.24
- 2009 EPS of $1.65, revenue per share of $7.22
- 2010 EPS of $2.53, revenue per share of $9.15
The market has clearly disagreed with my assessment of T. Rowe. The company has traded at a 1.26x premium to the S&P500’s PE ratio over the last decade. I do not believe the company possesses a strong competitive advantage that will insulate it from the effects of competition going forward.
As a result, I do not believe the company should command a premium over the S&P500’s PE ratio. Historically, the S&P500’s PE ratio has averaged 15. I place the fair multiple for T. Rowe at 15. The fair value for the company today, with current ultra-low interest rates and an overvalued market is around 18, in line with the S&P500’s current PE ratio. T. Rowe currently trades at a PE ratio of 17.5, making it about fairly valued relative to inflated market levels, and slightly overvalued relative on an absolute basis based on my analysis.
Rowe Price Group has had a strong 27 year run of increasing dividends. I believe the company’s competitive advantage has significantly weakened over the last decade with the rise of low cost ETFs and the difficulty the company has in differentiating itself from competition. As a result, I believe there are better dividend growth options available elsewhere for investors seeking growth and/or income.