Updated on January 16th, 2019 by Nate Parsh
Investors looking for high-quality dividend growth stocks, should look first and foremost at the Dividend Aristocrats. The Dividend Aristocrats are an exclusive list of 53 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 32 years in a row, including a 22.8% hike on February 13th, 2018. T. Rowe Price has a strong brand, a highly profitable business, and future growth potential.
The stock has a 3% 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.
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 United States. Today, the company has a market cap of $23 billion and manages over $1 trillion 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: 2018 Shareholders Meeting, page 3
This is a difficult climate for asset managers. The onset of low-cost exchange traded funds, or ETFs, have successfully lured client assets away from traditional mutual funds that have higher fees. In addition, the poor performance of the S&P 500 Index last year is a negative catalyst for industry assets under management, or AUM.
However, T. Rowe Price continues to perform well, and the company has strong growth potential in the years ahead.
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 the third quarter (September 30th) with $1 trillion in assets under management. AUM increased 15.6% from the previous year. AUM improved 3.5% from the second quarter of 2018. The following image shows T. Rowe Price’s successful long-term AUM growth.
Source: 2018 Shareholders Meeting, page 8
This is excellent growth, and will help drive higher revenue through investment fees. This has already started to occur. The company has seen net revenues increase 16% for the first three quarters of 2018. This is an acceleration from T. Rowe Price’s net revenue growth of 13.6% in 2017.
Specifically, T. Rowe Price has benefited from the flow of investor capital away from actively-managed products, toward passive investments. 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 1.1 million of its own shares in the third quarter for a total price of $124.5 million. The company saw its share count decline 1% year-over-year.
For the first three quarters of 2018, T. Rowe Price has repurchase 5.4 million shares worth $575 million. This has reduced the number of outstanding shares by 2.2% from the prior year. Overall, adjusted earnings-per-share increased 37% in the third quarter.
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. Over the past 10 years, over half the company’s mutual funds placed in the top quartile of performance among their peer group.
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.
Source: 2018 Shareholders Meeting, page 6
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)
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
We expect T. Rowe Price to produce adjusted earnings-per-share of $7.15 for 2018. Using the recent closing price of $93, the stock has a price-to-earnings ratio of 13. We have a 2023 target price-to-earnings ratio of 18, which indicates the stock is significantly undervalued at the present time. If the stock valuation expands to the fair value estimate, annual returns would be boosted by 6.7% just from valuation expansion.
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.
We see earnings-per-share increasing 26.5% for 2018, but growing at a rate of 6.5% annually through 2023.
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:
- 6.5% earnings growth
- 3% dividend yield
- 6.7% multiple expansion
T. Rowe Price is a particularly attractive stock for dividends. The company has raised its dividend for over 30 years in a row, including a huge 32% increase last year. And, the dividend has an attractive yield of 3%. Plus, the dividend is highly secure, as the following video further illustrates:
From the combination of valuation changes, earnings growth, and dividends, T. Rowe Price could offer investors annual returns of 16.2% through 2023, a very attractive expected rate of return for a Dividend Aristocrat.
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. With a high expected rate of return and a 3% yield, T. Rowe Price is a buy for dividend growth investors.