T. Rowe Price (NASDAQ:TROW) is one of Wall Street's largest asset-management companies with approximately $991 billion of total assets under management. Its record of long-term dividend growth puts it among a special group of so-called Dividend Aristocrats, which are stocks that have increased their dividends for 25 consecutive years, or more.
Looking in the rearview mirror is easy. Predicting what the future holds is hard. As an active investment manager, T. Rowe Price's core business is under threat of disruption from low-cost passive funds and ETFs, and its growth hinges on a select group of all-star funds.
Let's look at the safety of T. Rowe Price's current dividend yield and its prospects for increasing its dividend yield over time.
How safe is its current dividend?
You don't have to be at the top of your accounting class to see that T. Rowe Price should be able to maintain its current dividend for a very long time, thanks to a cash-rich balance sheet and a low dividend payout ratio.
- The balance sheet is rock solid. T. Rowe Price has about $3.2 billion of net cash and investments on its balance sheet (cash and investments minus all liabilities), and it doesn't carry any long-term debt. On a per-share basis, the company has about $13.07 of liquidity compared to annual dividend payouts of $2.28 per year ($0.57 per quarter).
- Its payout ratio is relatively low. T. Rowe Price has paid out less than 50% of net income in every single year since 2009, when it paid out roughly 61% of its earnings. A lower payout ratio gives it a buffer for bad years, ensuring that the company can increase its dividend even when earnings fall. Even in the disastrous year of 2009, net operating income fell roughly 30% from its 2007 peak. I consider its 2009 performance to be a good "stress test" for how its earnings would be impacted by a severe economic downturn and stock market decline.
Of course, these safety nets only ensure that T. Rowe Price can maintain its current dividend. Its ability to grow its dividend over time is another story, as in the long run, a company can only grow its dividend as fast as earnings. Let's look at some of the fundamentals that underlie its core business.
A changing industry
Make no mistake about it, the asset-management industry is changing quickly. Investors are turning to low-cost index mutual funds and ETFs, eschewing high-cost actively managed funds like those offered by T. Rowe Price.
Index funds have an inherent advantage over actively managed funds. They avoid the high cost of marketing and distribution, and avoid paying high salaries for analysts and stock pickers. As a result, index funds can compete on cost, and many carry expense ratios of 0.10% or less. In contrast, actively managed stock funds carried an average fee of 0.82% in 2016.
T. Rowe Price is in a better position than other active managers, including fellow dividend aristocrat Franklin Resources. Most of its assets under management come from long-term accounts like retirement plans and annuities, whose investors have historically been less likely to pack up and leave for less expensive funds. Furthermore, T. Rowe Price's scale enables it to offer actively managed products at a much lower price than smaller managers.
The company's most expensive products, stock and blended mutual funds, carried a weighted-average advisory fee of just 0.58% of assets in 2016. Its least expensive strategies -- bond, money market, and stable value separately managed accounts -- carried fees of just 0.24% of assets last year.
T. Rowe's biggest growth driver
To understand what's driving T. Rowe's growth, look no further than a handful of target-date funds that are carrying the company and papering over stagnating assets under management (AUM) in other legacy funds and strategies. It's difficult to understate the importance of this product line. In all, target-date strategies (funds and trusts) account for more than $223 billion of client assets, or approximately 24% of the firm's total AUM.
Target-date products are most popular in a mutual fund wrapper, sold to investors primarily through retirement plans like 401(K)s. Mutual funds in this product group accounted for $166 billion of AUM, or roughly 18% of all client assets, and they remain the single most important source of inflows. At the end of 2007, less than 10 years ago, these funds held only $30 billion of assets, or about 8% of the company's AUM.
T. Rowe is well aware of its extraordinary success with target-date products, boasting at its investor day that "since inception of each Retirement Fund in the series, 100% of the funds (9 funds studied) have outperformed their designated benchmarks in 100% of the rolling 10-year periods." T. Rowe is riding its hot hand.
Risks to T. Rowe Price
There are a number of risks to T. Rowe Price's earnings power and its ability to pay an ever-increasing dividend. Many of its obvious strengths are also its most obvious risks.
Like all asset managers, T. Rowe Price benefits from a natural tailwind of rising stock and bond prices over time, since it derives the vast majority of operating revenue from variable fees based on the value of its investors' assets. The downside is that earnings power falls fast in bear markets.
In 2009, the company reported that advisory fee revenue fell 18% from its 2007 peak. Profits fell even faster, as net operating profit plunged 30%. Stock strategies make up roughly 57% of assets under management, which is a boon in bull markets and a bust in bear markets.
Distribution is the most important piece of the business model. T. Rowe Price's greatest strength is its entrenched position as an asset manager for retirement plans and other long-term accounts. Investment missteps in its most popular funds could weaken its competitive position as it solicits new clients.
Its target-date funds have been a huge winner, but as they grow, more of its success hinges on the success of just a few funds in its lineup. It certainly doesn't help that Vanguard, which has no profit motive, is a fast-growing force in retirement-plan administration. For its part, Vanguard offers a competing target-date product line based on low-cost index funds.
Finally, pricing power is a perennial question mark for fund managers, who have to compete with an increasing number of lower-fee index funds and robo-advisors. Remarkably, T. Rowe Price's average fee on investor assets (roughly 0.48%) has changed very little in the past decade, despite a general decline in fund fees. Whether that's evidence that T. Rowe Price won't lose pricing power ever, or whether it simply reflects the fact it hasn't lost pricing power yet, is a difficult question to answer.
Thriving in a declining industry
The best way to sum up T. Rowe Price is that it's one of the best-positioned companies in a generally declining industry. That's not to say the company is doomed.
One could reasonably argue that T. Rowe Price and other large-scale asset managers will actually win as the industry consolidates due to fee compression, since smaller companies that can't compete at lower price points will be shaken out. Their customers have to turn somewhere, and scaled asset managers could pick up assets on the margin, as smaller shops shutter their doors.
The economics of the business favor scaled asset managers. The company generates advisory revenue roughly equal to 0.48% on average assets under management, but its operating expenses add up to about 0.29% of average assets, giving it a lot of wiggle room to cut fees if pricing actions can help it corral more fee-earning assets.
Rather than obsess about the passive vs. active management debate, investors should focus on T. Rowe's biggest immediate risk, which is that its fast-growing, higher-fee target-date funds lose their place in American retirement accounts. These high-margin strategies generate above-average fees, and their inflows help paper over outflows in legacy funds -- but funds can't thrive on a few years of high returns. T. Rowe Price will have to keep winning for its clients to keep fund flows heading in the right direction.
The company's dividend is safe for now, but I'd argue that asset managers aren't exactly "buy and ignore" dividend stocks. A better label might just be "buy and babysit," given how quickly the asset management industry is evolving, and how much of T. Rowe's growth relies on a small number of particularly hot retirement funds.