When the market stumbled this spring, T Rowe Price (TROW, Financial) went down with it, but it quickly revived:
Despite the recovery, shares are still on sale according to the GuruFocus discounted cash flow (DCF) calculator, which estimates there is nearly a 20% margin of safety.
The firm is one of the best-known investment managers. It desribed itself as follows in its Q1-2020 earnings release:
“Founded in 1937, Baltimore-based T. Rowe Price (troweprice.com) is a global investment management organization that provides a broad array of mutual funds, subadvisory services, and separate account management for individual and institutional investors, retirement plans, and financial intermediaries.”
At the latest report, it was managing just over $1 trillion in assets, and its principal method of doing business was with mutual funds. Which raises the question, is an investor better off buying the company’s mutual funds or the company itself?
Financial strength
With a 7 out of 10 GuruFocus rating, the company is well-positioned financially, and in part that’s due to the low level of debt it has taken on.
According to the financials, at the end of 2019, T Rowe Price had $146 million in long-term debt and $1.78 billion in cash and cash equivalents. Hence, the high cash-to-debt ratio.
You’ll notice the red bar signifying that its debt now is worse than it was in the past. That’s explained by observing it had no long-term debt in the past decade, until we got to 2019.
Another clear sign of financial strength is that its return on invested capital (ROIC) is higher than its weighted average cost of capital (WACC) ratio, showing the difference between what it earns from borrowed funds and funds from investors, and what it pays to get those funds. Its weighted average cost of capital is 7.59%, while its return on invested capital is 28.97%.
Profitability
With a GuruFocus profitabilty rating of 9 out of 10, the company has high profitability, buoyed by a string of strong metrics. Let’s first take a look at its operating and net margins:
So, T Rowe Price’s operating margin may have slipped in recent years, but the net margin has grown consistently over the past three years.
Its ROE (return on equity) and ROA (return on assets) are both very good. The same is true for its revenue, Ebitda and earnings per share without NRI (non-recurring items).
Valuation
T Rowe Price receives a medium-low rating of 4 out of 10 for its valuation, meaning it is considered somewhat overpriced on some metrics.
Let’s bring back the 10-year price chart:
Between the low of 2017 and today, the share price has more than doubled, but is it overpriced?
The green bar in the history column suggests the price-earnings ratio is now lower than it has been in the past. Over the past ten years, this metric has varied between 11.5 and 46.38, and the median has been 18.11. At 16.62, it is below its previous high and above its previous low.
The red bar adjacent to the price-earnings ratio indicates the company is at something of a disadvantage when compared to its peers and competitors:
Using the default parameters of the GuruFocus DCF calculator, T Rowe Price comes up as undervalued, a valuation in which we can have reasonable confidence given its Business Predictability Rating of 4 out of 5 stars. It has a margin of safety of almost 20%.
Dividends
T Rowe Price is one of America’s premier dividend companies because it has earned Dividend Aristocrat status. Standard and Poors developed the index to highlight companies that were in the S&P 500, had a market cap of at least $3 billion and had increased their dividends for at least 25 consecutive years.
Its current dividend yield is 2.49%, roughly a half-point above the S&P 500 average. Here’s the yield in the context of share prices, over the past decade:
Here's the history of dividends per share:
With a payout ratio of 40%, the dividend should be quite sustainable. For confirmation, we review the trend of the source of dividend funding, i.e. free cash flow:
The forward dividend yield has risen to 2.7% from the trailing 12-months yield of 2.49, indicating a recent increase in the dividend. On Feb. 12, the company increased its quarterly dividend from $0.76 to $0.90, representing an annual increase from $3.04 to $3.60.
What would be your average annual return from dividends alone, if you bought the stock, held it for five years and the company continued to increase its dividend at the same pace as it had for the past five years? The 5-year yield-on-cost tells us the average annual return would be 4.2%.
Additionally, over the past three years, the stock buyback ratio has been 1.3. Most recently, the company repurchased shares in March when the price slipped:
“We responded to the drop in our share price and to higher trading volumes in Q1 by repurchasing 8.3 million shares. Total shares outstanding finished Q1 at 228.0 million, the lowest level since 1986. Still, our balance sheet remains rock-solid, and we will continue to invest in our business for the long term.”
Gurus
At the end of March, nine gurus had positions in T Rowe Price. The largest of those holdings belonged to Pioneer Investments (Trades, Portfolio) with 725,505 shares representing 0.32%, of the asset manager’s shares outstanding.
Ron Baron (Trades, Portfolio) of Baron Funds held the second-largest number of shares with 329,435, while Tom Gayner (Trades, Portfolio) of Market Gayner Asset Management held 314,000.
Buy the funds or buy the company?
To get back to our original question, should you buy the company or one or more of its funds? We will compare the company with one fund: the T. Rowe Price Dividend Growth Fund (PRDGX, Financial). It offers growth from both capital gains and dividends, so I think it would be roughly comparable.
The $14.9 billion fund has these characteristics:
- Alpha: 0.58
- Beta: 0.84
So we have a fund in which the manager has outperformed the benchmark by more than half a point and its beta shows it to be slightly less volatile than the overall market. It appears to be broadly similar to owning the stock.
According to Morningstar, the Dividend Growth Fund has averaged 13.76% per year over the past 10 years (ending Dec. 31, 2019). That is certainly a satisfactory yield, but it pales next to the 25.48% ROE averaged by the stock. Note, this is a very rough comparison and does not account for a host of variables, but when the stock’s performance begins with a more-than-10-point advantage, it may have an insurmountable lead.
Another fund that might be comparable is the Large-Cap Value Fund - I Class (TILCX, Financial), which averaged 10.22% over the past decade. It is a no-load fund with a net expense ratio of 0.56%. Again, the company handily outperforms one of its funds.
Conclusion
T Rowe Price is and has been an outstanding stock in terms of its fundamentals, its dividend history and its returns.
Thanks to the fundamentals, a history of good management and the DCF valuation, this company should suit value investors and income investors with long time horizons. For income investors with shorter perspectives, I think there are other mature companies with more enticing yields.
Disclosure: I do not own shares in any companies named in this article.
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