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The Biggest Threat to T. Rowe Price Group Stock

By Dan Caplinger - Apr 24, 2016 at 10:41AM

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The mutual-fund giant has an Achilles heel. Find out what it is.

Image: T. Rowe Price.

Helping people invest is a trillion-dollar industry, and a host of financial institutions compete hard to attract money from potential investors. Mutual-fund company T. Rowe Price Group ( TROW -3.03% ) has a history going back decades in providing investors with no-load funds in which to invest, and it has built up a reputation for making early investments in innovative, high-profile companies in the technology space. However, T. Rowe Price faces plenty of risks, and two in particular pose a major threat to its business and its stock price. Below, we'll look at these two risks and how they add up to something T. Rowe Price investors will want to keep their eye on over the long run.

The threat: a changing market
Both of T. Rowe Price's major risks are tied to the fact that the asset management business is subject to constant change. First, market movements affect the amount of assets that T. Rowe Price has under management, and because the company gets most of its revenue from percentage-based management fees, anything that hurts its asset base hurts its ability to generate income. Second, the demand from investors for traditional mutual funds has waned in recent years, as the rise of exchange-traded funds has diverted away investing capital over which that T. Rowe Price and other mutual-fund specialists used to have a firm grip.

A tough start to 2016 has led investors to have low expectations for T. Rowe Price this year. Earnings for the first quarter could fall as much as 10%, and the consensus forecast among investors is for T. Rowe Price to see full-year 2016 earnings fall from 2015 levels on a slight pullback in revenue. The stock market's big rebound since February has lessened the severity of the expected earnings decline, but past episodes of market volatility have led fund investors to sell shares, and a repeat performance could hurt T. Rowe Price substantially.

Adapting to changing conditions
To compete against ETFs, T. Rowe Price has made the most of its expertise to attract investors. Unlike many fund companies, T. Rowe Price has made a substantial business of offering venture financing to companies that aren't yet publicly traded. One recent example is room-sharing service Airbnb, in which T. Rowe Price has participated with funding rounds that have valued the privately held company at $25 billion. Past investments in pre-IPO funding rounds for social-media giant Facebook gave investors early access to the company, attracting considerable capital to T. Rowe Price's funds.

Still, that strategy doesn't always work well. In just the past month, T. Rowe Price has had to mark down the value of most of its tech-start-up holdings, including Uber, Dropbox, and Cloudera. For the most part, funds hold minuscule amounts of these start-ups, so fund shareholders won't necessarily see big losses because of the moves. However, when T. Rowe Price has to report that it hasn't produced the big profits that fund investors had hoped to see, it takes away from the incentive to invest more money in the company's mutual funds.

T. Rowe Price is also working to stay ahead of industry trends and offer the products that potential investors want to see. For instance, the company recently introduced three new stock mutual funds that use quantitative management to guide their investing decisions. The quantitative movement has gained steam in recent years as a complement to more fundamentally based research, and T. Rowe Price hopes that models designed to take advantage of trends in companies' financial performance to find investing opportunities in key data will inspire more customers to keep their investing money with the mutual-fund giant. Yet if those efforts don't pan out -- or if the quantitative funds aren't able to outperform their exchange-traded fund rivals -- then T. Rowe Price runs the risk of being rendered obsolete by the changing landscape of the financial services industry.

T. Rowe Price Group has a long history of delivering healthy returns to its shareholders, and even though the nature of the industry has changed over time, the company still has a large number of loyal mutual fund investors that it serves. Despite the threat of changing markets, T. Rowe Price has shown that it can adapt to the ongoing evolution of financial services for decades, and there's no reason to believe it can't overcome the current threat.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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