T. Rowe Price's (TROW 4.77%) business can be summarized in one statement: It manages money for other people. That tells you a huge amount about the business, helping to explain why the stock has declined 50% from its 2021 highs and why the company believes it can still afford its 4.4% dividend yield. But there are some important nuances to understand here, including a discussion of the asset manager's balance sheet.
The core of the story
At the end of the first quarter of 2023, T. Rowe Price had assets under management (AUM) of about $1.34 billion. This is, perhaps, the most important number to watch here because AUM represents the money that the company manages on behalf of others. The fees it charges, for things like mutual funds, are generally based on a percentage of the assets managed. So, as AUM goes up and down, so does revenue and earnings.
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Here's the problem. At the end of Q1 2022, AUM stood at $1.55 billion, roughly 14% or so higher. It shouldn't come as any surprise that T. Rowe Price's Q1 earnings were lower by 35% or so. But this is just par for the course in the asset management business.
The key here is that there are two ways that AUM both rises and falls. The most obvious is that customers give T. Rowe Price money or withdraw their money. This is normally a pretty small component of the overall change because customers tend to be sticky, meaning they don't often leave. It takes extra effort to move to another asset manager, and inertia is a strong force to overcome.
Most of the big swings come from market moves, with bull markets leading to big AUM increases and bear markets leading to substantial declines. But, historically, bulls follow bears and vice versa. T. Rowe Price isn't going to make major changes just because of the normal Wall Street cycle. That includes on the dividend front.
A big positive
In fact, T. Rowe Price has increased its dividend annually for more than 35 consecutive years. There have been a fair number of bull and bear markets during that span, including the one during the Great Recession. If the Great Recession, a period where many thought the global financial system was at risk of collapse, wasn't enough to justify a dividend cut, well, the recent stock price decline really shouldn't be too much to suffer through.
But there's more to the story here. Dividends are paid out of cash flows, but companies have different demands on their cash flow. T. Rowe Price has worked hard to ensure that the demands on its cash flow are as minimal as possible by having a debt-free balance sheet. Don't pass this off as a small thing, because it is not.
When revenue falls, it becomes harder for heavily indebted companies to cover their interest costs. T. Rowe Price doesn't need to worry about that. When interest rates rise, interest expenses become more burdensome. T. Rowe Price doesn't have to worry about that. This provides it with much more flexibility, including with regard to the dividend, than a peer with debt.
The full story
So there are really two sides to T. Rowe Price's ability to keep paying its historically high dividend. First, the company knows that its asset management business is resilient and that, eventually, the next market upturn will push AUM higher. Second, a rock-solid financial foundation gives it the fortitude to ride out Wall Street's inevitable cycles in relative stride. That's the combination that sets T. Rowe Price apart from the pack.
