Investment management company T. Rowe Price (TROW 0.04%) isn't a brand you'll hear about much from your friends and family. However, it's a staple in the dividend community. T. Rowe Price has paid and raised its dividend for 37 consecutive years, and the stock has obliterated the S&P 500 over its lifetime.
But today, the stock is down 50% from its high. Is this a half-off sale worth jumping on, or is the market telling investors something they don't yet know? Understanding how the business works is key to knowing whether to own the stock.
Once you peel back the data, the stock begins to stand out as a compelling long-term idea worthy of any long-term investor's portfolio. Here is what you need to know.
Understanding how T. Rowe Price makes money
T. Rowe Price is an investment management company. It offers various investment products like mutual funds and exchange-traded funds (ETFs), as well as wealth advisory services. You'll want to focus on its assets under management (AUM) as an indicator of how the business is doing, which is the value of the cumulative funds invested.
The company generates revenue from fees, charging a tiny percentage of its AUM. As of the first quarter of 2023, T. Rowe Price had $1.34 trillion under management, and revenue is just over $6 billion over the past four quarters.
TROW Revenue (TTM) data by YCharts
T. Rowe Price's AUM is impacted by two variables: net inflows (funds investors put in and pull out) and the market value of everything invested. In other words, T. Rowe Price's business can fluctuate in bull and bear markets because prices fall and people invest less during bad times and do the opposite during good times.
As you may be aware, the market can swing wildly in the short term, and so can T. Rowe Price's business. But just as the stock market has historically always moved higher over time, T. Rowe has continued growing -- one of the most remarkable aspects of the company. It also makes T. Rowe Price somewhat immune to inflation because it's right there to take its small pound of flesh as the markets move higher.
Just how good a business is this?
Besides paying employees and marketing expenses, T. Rowe Price doesn't have many expenses. The business is asset-light, which translates into stellar financials. The company converts about a third of its revenue into free cash flow, and the business keeps stacking cash on a balance sheet with zero debt.
TROW Free Cash Flow (% of Annual Revenues) data by YCharts
You could call T. Rowe Price a cash cow, given how it puts money into shareholders' pockets. Not only has T. Rowe Price continually grown its dividend, but it also finds the money to pay the occasional special dividend and fund enough share repurchases to reduce outstanding shares by nearly 14% over the past decade.
Good things generally happen when you buy and hold steadily growing companies that keep returning profits to shareholders. It's all you need to know about how the stock has performed so well over the years.
Why the stock is worth buying today
So why is the stock down today? Remember how I mentioned that T. Rowe Price's business is sensitive to the market's ups and downs? Well, 2022 was a doozy, and not in a good way. Both stocks and bonds were hit hard, which trickled down to T. Rowe Price. The company's revenue declined by 15% from 2021, and earnings were chopped in half.
While the stock market is off to a better start in 2023, both bonds and stocks remain notably off their former highs. Investor sentiment can also take time to recover, so T. Rowe Price's business may take some time to get up to speed again. Analysts believe the company's earnings per share will grow by 6% annually over the next few years, giving investors potential 11% annual returns adding in T. Rowe Price's 4.5% dividend yield.
The stock is priced at a forward price-to-earnings ratio of 16 despite the challenging year in 2022. One could argue that a new bull market could rejuvenate the business beyond analyst expectations, making today's valuation seem even better in hindsight. Given T. Rowe Price's excellent financials and a range of likely annual investment returns starting at double digits, the stock is a strong contender for any long-term portfolio.
