Stubborn inflation well above the Federal Reserve's 2% target, elevated interest rates, and slowing economic activity are all warning signs of a potential recession in 2023. A survey of economists suggests that the probability of an economic downturn coming to the U.S. within the next 12 months is around 68%.
With a potential recession on the way, investors often adjust their portfolio strategies to prepare. When done right, dividend growth investing has proven itself to be a durable strategy no matter the economic environment. This is because the best businesses are operating well enough to raise their payouts no matter what is going on in the world.
T. Rowe Price Group (TROW 0.40%) has raised its dividend annually for 37 consecutive years. This track record of growth raises the question: Is this stock a buy for investors seeking reliable income? Let's take a closer look at T. Rowe Price's fundamentals and valuation to see if an answer arises.
T. Rowe Price is enduring short-term pain for long-term gain
In its 80-plus years in business (it went public in 1986), T. Rowe Price has served its customers during countless recessions (including the Great Depression), several military conflicts, and various social upheavals. The company's performance throughout all these crises earned it the trust of its clients. The global investment management firm offers funds, sub-advisory services, account management, and retirement plans and services for individuals, institutions, and financial intermediaries. With nearly $1.4 trillion in assets under management (AUM) as of April 30, T. Rowe Price is among the largest asset managers in the world.
As impressive as the current AUM figure is, it was hovering around $1.7 trillion in December 2021. The combination of falling financial markets and the outflow of assets from T. Rowe Price's funds over the past 18 months or so has meaningfully reduced the company's AUM.
The Baltimore-based asset manager's net revenue dipped 17.5% year over year to $1.5 billion in the first quarter. This was the result of a 15.2% fall in its average AUM to $1.3 trillion. The company's investment advisory effective fee rate (assessed to clients as a percentage of AUM for services) also declined by 0.5 basis points to 42.7 basis points during the quarter. These two factors explain the double-digit drop in net revenue for the quarter.
T. Rowe Price's non-GAAP (adjusted) diluted earnings per share (EPS) plunged 35.5% over the year-ago period to $1.69 in the first quarter. Because a recovery is anticipated in its business in 2024 and beyond, there was only so much cost-cutting the company could reasonably execute. Since operating expenses weren't reduced as much as net revenue, non-GAAP net margin plummeted by 780 basis points to 25.3% during the quarter. This sizable decrease in profitability was only partially offset by a lower diluted share count, which is why adjusted diluted EPS fell at a faster clip than net revenue for the quarter.
Image source: Getty Images.
The payout is well-covered by profits
T. Rowe Price's 4.5% dividend yield is quite generous when put up against the S&P 500 index's 1.6% yield. And investors can also rest assured that the payout can keep growing in the future.
This is because it is estimated that T. Rowe Price's dividend payout ratio will clock in just below 73% in 2023. Although this isn't an ideal payout ratio for an asset manager, the company's earnings are likely going to bottom out this year. And as T. Rowe Price returns to earnings growth in the years ahead, it's reasonable to expect modest dividend growth to persist. Given that the starting income provided by the company is quite high, it doesn't take much growth in the payout for the stock to appeal to income investors.
A stock worth observing
T. Rowe Price's forward price-to-earnings (P/E) ratio of 15.4 is significantly higher than the asset management industry average forward P/E ratio of 11.4. The stock is arguably worth such a lofty premium valuation based on its track record of outperformance versus its peers.
But investors buying in at the current $106 share price may face material downside if a more severe economic downturn occurs. This is why I would advise income investors to cautiously buy in bits and pieces as the months unfold and to jump on any major weakness in the stock.
