Last Updated on August 6, 2023 by Prakash Kolli
T. Rowe Price (TROW) – An Undervalued Dividend Aristocrat. The market has been on the move lower as the S&P 500 broke a huge trend line on the weekly chart on January 18. With that move lower, the market brought more stocks back to earth and many are now at a more reasonable price level.
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Overview of T. Rowe Price
In today’s article, we will cover a global investment management organization with $1.58 trillion in assets under management (AUM) as of January 31, 2022. This company is a high-quality dividend growth stock. T. Rowe Price (TROW) was founded in 1937. The firm provides mutual funds, sub-advisory services, and separate account management for individual and institutional investors, retirement plans, and financial intermediaries. The company also offers sophisticated investment planning and guidance tools. Total revenue was approximately $7,672 million in 2021 and the last 12 months.
TROW’s Dividend History, Growth, and Yield
TROW was down 35% since its all-time high in November 2021. However, the current stock price of $144.25 (as of this writing) is currently at the low of the 52-week range, which is between $143.44 and $224.56 per share. Thus, TROW looks like a stock that seems to be in the right place to buy shares.
We will now look at TROW’s dividend history, growth, and yield. We will then determine if it’s still a good buy at current prices.
TROW is considered a Dividend Champion and a Dividend Aristocrat, a company that has increased its dividend for more than 25 years. In this case, TROW had increased its dividend for 35 consecutive years. TROW’s most recent dividend increase was 11.1% which was announced in February. Also, TROW has a five-year dividend growth rate of about 14.9%, which is impressive, and the 10-year dividend growth rate is roughly 13.3%.
Something essential to note is that TROW continued to pay its dividend during the most challenging period in the last 100 years. Most businesses and industrials were cutting or suspending their dividends payments during the COVID-19 pandemic; TROW, however, continued to pay out its dividend and increased it. That is very remarkable. This fact alone leads me to believe in the strength of the company and the fact that management is focused and committed to the dividend policy.
The company has an excellent forward dividend yield of 3.3% as of this writing, which is more than double the current dividend yield of the S&P 500. This yield is a respectable initial yield for those income-driven investors. This dividend yield is also really good for investors leaving the bond market looking for higher yields.
However, Income-driven investors may want a 4.5% yield or higher. TROW does not meet those criteria right now, but with the current dividend growth, in 8 to 10 years, I am sure that the yield on cost would be much higher than 4.5%.
TROW’s current dividend yield is higher than its own 5-year average dividend yield of 2.5%. I like to look at this metric because it gives me a good idea if a company I am researching is undervalued or overvalued based on the current and 5-year average yield. This point is because price and dividend yield correlates inversely with one another. If the price goes higher, then the dividend yield goes lower. Vice versa as well.
Let’s determine if the current dividend is safe? Dividend safety is a critical metric to look at as a dividend growth investor. Sometimes, undervalued dividend stocks can present us with a “value trap,” and the stock price can continue to head lower.
To determine if the dividend payments are safe every year. First, we must look at two critical metrics. The first one is earning-per-share (EPS), and then we must investigate Free Cash Flow (FCF) per share.
Analysts predict that TROW will earn an EPS of $13.32 per share for the Fiscal Year (FY) 2022. Analysts are very accurate when predicting TROW futures EPS. The company is expected to pay out $4.80 per share in dividends for the entire year. This value will give us a payout ratio of 36% based on estimated EPS. Having a 50% or lower dividend coverage with a dividend yield of over 3.0% gets me very excited. This low payout ratio will allow the company to continue to grow its dividend at a double-digit rate, as has it has been doing the past ten years.
In addition, TROW has a dividend payout ratio of 27% on a FCF basis. Thus, the dividend is well covered in both EPS and FCF.
As with all investment ideas, there are always risks. TROW’s most significant risks are that it is very dependent on the stock market. For example, a substantial decline in the market, or changes in investor behavior resulting in outflows of funds, can impact TROW’s revenues and thereby its share price. For example, as more and more people retire, they will start pulling out their money to fund their lifestyle. This action will lower TROW total Assets Under Management (AUM), which will lower TROW total fees collected. Alternatively, poor fund performance will cause investors to pull out their money resulting in lower AUM and thus revenue and EPS.
TROW’s Capital Revenue and Earnings Growth / Balance Sheet Strength
We will now look at how well TROW performed and grew its EPS and revenue throughout the years. When valuing a company, these two metrics are at the top of my list to study. Without revenue growth, a company can’t have sustainable EPS growth and continue paying a growing dividend.
For the past ten years, TROW revenues have been growing satisfactorily at a compound annual growth rate (CAGR) of about 9.5%. Net income likewise has been growing healthy throughout these past ten years at ~11.2% CAGR per year.
However, EPS has seen a much better growth rate than revenue and net income. EPS has grown ~17.8% annually for the past ten years. And over the past five-years, EPS has had a CAGR of ~19.5%. In addition, EPS has had a significant increase from FY2020 to FY2021, with a 28% year-over-year gain. In addition, analysts predict that the company will grow EPS at a 5% rate over the next five years.
Last year’s EPS increased from $9.98 per share in 2020 to $12.75 per share for 2021, was a significant increase of 28%. However, analysts expect TROW to make an EPS of $13.32 per share for the fiscal year 2022, which would be a 4% increase compared to 2021 as growth slows.
Additionally, the company has a solid balance sheet. Currently, TROW has an S&P credit rating of A+, which is an upper-medium investment grade credit rating. Furthermore, the company has a debt-to-equity ratio of 0.2X, which is excellent. T. Rowe Price is also one of the few companies with no debt on its balance sheet. The company has a net cash position of around $1,523 million at end of 2021. Thus, the company has a strong balance sheet to overcome significant economic downturns like the COVID-19 pandemic or inflation.
TROW is Undervalued
One of the valuation metrics that I like to look for is the dividend yield compared to the past few years’ histories. I also want to look for a lower price-to-earnings (P/E) ratio based on the past 5-year or 10-year average. Furthermore, I like to use the Dividend Discount Model (DDM). I use a DDM analysis because a business is ultimately equal to the sum of the future cash flow that the business can provide.
Let’s first look at the P/E ratio. TROW has a P/E ratio of 10.8X based on Fiscal Year (FY)2022 EPS of $13.32 per share. The P/E multiple is low compared to the past 5-year PE average of 14X. If TROW were to revert to a P/E of 14X, we would obtain a price of $205.13 per share.
Now let’s look at the dividend yield. As I mentioned, the forward dividend yield currently is around 3.33%. Looking at TROW’s own 5-year dividend yield average of ~2.48%, there is good upside potential. For example, if TROW were to return to its dividend yield 5-year average, the price target would be $171.43.
The last item I like to look at to determine a fair price is the DDM analysis. I factored in a 10% discount rate and a long-term dividend growth rate of 7%. I use a 10% discount rate because of the higher-than-normal current dividend yield. The projected dividend growth rate is lower than its past 5-year average but conservative. This calculation gives us a fair price target of $171.20 per share.
If we average the three fair price targets of $205.13, $171.43, and $171.20, we obtain a reasonable, fair price of $182.58 per share. This value gives TROW a possible upside of 26.6% from the current price of $144.25 per share illustrating that the stock is undervalued.
Conclusion on T. Rowe Price (TROW) – An Undervalued Dividend Aristocrat
TROW is a high-quality company that should meet most investors’ requirements and is undervalued today. The company has a market-beating 3.3% yield, double-digit long-term dividend growth recorded, it’s a Dividend Champion and a Dividend Aristocrat with more than 25 consecutive years of dividend increases, and a low payout ratio. Furthermore, TROW has shares that are potentially 26.6% undervalued. In addition, T. Rowe Price is a world-class corporation on sale. Thus, I view it as a long-term buy.
Disclosure: Long TROW
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My name is Felix Martinez, and I am a Dividend Growth Investor who has invested in dividend growth stocks for the past seven years. I also run a YouTube channel called FiscalVoyage. I have written for SeekingAlpha.com as well as SureDividend.com. I focus on undervalued dividend growth stocks with capital return and dividend income potential. Make sure to follow me on my YouTube Channel. See you there.