Make money while you sleep -- who doesn't want that? One easy way to generate passive income is by investing in dividend stocks. Dividend stocks are companies that make distributions to shareholders in the form of cash payments.
Not all dividend stocks are equal, though. Some stocks pay out a high dividend yield that can fluctuate with the performance of the business, while others commit to paying out a regular distribution that grows annually in a gradual manner. The latter approach can be a more reliable source of income because these companies have withstood the test of time and have not wavered in paying out dividends irrespective of the macroeconomic backdrop.
Raising dividends consistently over decades is no easy feat, as companies have to deal with different phases of the economic cycle, including recessions. To navigate these uncertain times, companies must have steady cash flows and strong capital management.
One company that has raised its dividend every year since 1987 is the asset manager T. Rowe Price (TROW -0.79%). Here's why T. Rowe Price is an income stock you can rely on.
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A 37-year streak of raising dividends
T. Rowe Price is a respected asset manager that provides investors with investments including mutual funds, exchange-traded funds (ETFs), and alternative assets.
For asset managers, assets under management (AUM) are the name of the game. That's because these companies earn a fee based on the size of the funds they manage. Because of this, these fees can be pretty reliable -- as long as there isn't a massive outflow of investor funds. At the end of last year, T. Rowe had $1.27 trillion in AUM.
The company has raised its dividend payout over 37 years -- a period that includes the 1990s recession, early 2000s recession, the Great Recession in 2008, and the most recent COVID-19 recession in 2020. This is an impressive feat, but it's not to say the asset manager hasn't faced challenges along the way.
T. Rowe Price has performed well in the face of significant headwinds
T. Rowe Price is an active manager, meaning that it has a team of investors who manage an investment portfolio and make buy, hold, and sell decisions to beat a designated benchmark. Active managers rely on investment analysis, research, and forecasts to decide which stocks to hold. This contrasts with passive management, where companies create a fund that tracks an index or other benchmark and aim to equal the returns of an index, like the S&P 500.
One thing that has weighed on T. Rowe's business over the last decade is the trend toward passive investing. Passively managed funds have grown in popularity due to their lower fees and the ease of buying them through ETFs. According to data from Statista, actively managed mutual funds accounted for 79% of total assets managed by investment companies in 2011. In 2021, these funds accounted for 57% of total funds.
T. Rowe Price has performed quite well despite this shift toward passive investing. Over the last decade, T. Rowe has grown its AUM by 10% compounded annually. This even includes last year, when its AUM dropped by over 24%. While a 24% drop isn't ideal, $348 billion of the $413 million decline was due to falling asset prices. The other $62 billion was due to customers pulling out funds.
Here's how active management could regain popularity
Active management has come under pressure from passive management in recent years. However, I don't believe passive management will keep growing at the same pace it has. That's because certain investing styles perform well in specific market conditions and interest rate regimes.
According to Hartford Funds Management Group research, active managers outperform passive managers during challenging market environments. One period where active managers recently outperformed was from 2001 through 2010. In the last 35 years, active management outperformed 18 years, while passive management outperformed 17 years. One could argue that active managers could find good demand if the economy remains challenging in the coming years.
We're in a different economic environment than that of the last decade. Inflation is still 5% (as measured by the year-over-year change in the Consumer Price Index), and the Federal Reserve will keep rates high until inflation comes down to its 2% target. Because of this, wise investors like Oaktree Capital's Howard Markets think that the era of ultra-low interest rates could be over. If this is the case, markets could see more volatility as investors adapt to higher interest rates than we've grown accustomed to, which could be a positive for active managers like T. Rowe Price.
Investor takeaway
T. Rowe Price has done a stellar job raising its dividend for 37 consecutive years. The asset manager has achieved solid growth and maintained an ever-increasing dividend despite the significant shift toward passive investing over recent years.
It's also on solid financial footing, with almost $1.8 billion in cash on its balance sheet and no long-term debt. T. Rowe Price currently yields investors a solid 4.3%, and its history of raising dividends across the last four recessions makes this an income stock you can trust.
