After lagging the S&P 500 for both the past five-year and one-year periods, T. Rowe Price Group (TROW 0.78%) stock has made a resurgence so far in 2016, shooting over 8% higher compared to the S&P's 2%.
Will T. Rowe stay red hot? It's impossible to know for sure, but these three things would go a long way to keeping the stock price moving from the lower left to the upper right.
1. Moving past January's market volatility
Perhaps the most influential condition that could drive T. Rowe Price Group stock higher is a steady, bullish stock market. Conversely, a volatile, panicky, or bear market would likely send the stock lower.
The reason for this is straight forward. T. Rowe Price is an investment company that generates revenue from fees charged on the client assets it manages in its mutual fund products. If the market rises, that has the two-fold advantage of increasing assets under management through appreciation and drawing more investors to the firm with fresh capital to invest. A panicky market tends to send shares lower, which simultaneously decreases fees on existing assets under management and makes it more difficult to bring in new investor capital.
This dynamic was on full display in the first quarter. The company's revenues declined 3% year-over-year thanks to a $25 million drop in investment advisory fees. CEO William Stromberg blamed the "volatile quarter for global markets" for driving average assets under management and fees lower for the quarter.
A rising market is, unfortunately, not something that T. Rowe Price Group's management or shareholders can control. For investors looking for something more concrete to hold onto, look no further than the company's balance sheet and the capital allocation benefits it provides.
2. More dividends!
T. Rowe Price currently reports no outstanding debt on its balance sheet. This is a conservative approach that's uncommon in large, public companies. Company's use debt, or leverage, as a tactic to boost earnings and return on equity. T. Rowe, however, has been able to generate very strong returns even without any leverage at all. The company's return on equity has been well above 20% on a trailing-12-month basis since the financial crisis.
Less debt makes a company's balance sheet stronger and resilient to financial troubles, and it also enhances free cash flow. Without the burden of debt service payments and principal pay downs, T. Rowe Price has more available cash to invest into the company's future or to return to shareholders. That's powerful, and allows the company to make deliberate capital allocation decisions. That could mean paying out high percentages of earnings as dividends, like the company did last year, or it could mean paying out lesser amounts and utilizing that capital for other purposes.
When considering a change that could immediately benefit the stock price, I think the most obvious event is an increase in the company's dividend.
T. Rowe Price currently pays a dividend of $2.18 per share, a payment that has increased every year for -- you won't believe this -- 29 consecutive years. The current yield is 2.78%.
On top of that regular check, the company has also been known to occasionally pay special dividends, some of which are quite large. In 2015, for example, T. Rowe paid shareholders an extra $2 per share on top of the regular dividend, effectively doubling it for the year.
A further increase to the regular dividend or the announcement of another large special dividend could be exactly the catalyst this stock needs to shoot even higher.
3. More buy backs!
The company's balance sheet and cash flow afford it more luxuries than just an unbelievably consistent dividend. Having all that cash gives the company the option to reinvest in its own future growth or, if market conditions are right, buy back its own stock. A large increase in stock buybacks could also be exactly what the stock needs to skyrocket this year.
This outcome seems reasonably likely as well based on the company's recent past. Over just the past year, T. Rowe Price Group has decreased the total shares outstanding at the company by over 5% through buybacks.
By buying back its own shares, the company increases the value of all the remaining shares -- that is, yours or mine. For example, if a company has 100 total shares outstanding and has a market cap of $1,000, each share would be worth $10 ($1,000 divided by 100 shares). If the company bought back 10 shares, then there would only be 90 total shares outstanding. The company's overall market value hasn't changed, meaning that each remaining share would now be worth $11.11 ($1,000 divided by 90 shares). Before the buyback, a single share represented 1% of the total ownership in the company. After the buyback, that same share now represents 1/90th of the company, or 1.11%.
T. Rowe is currently priced at 16.75 times its earnings on a trailing-12-month basis. Over the past six years the stock has tended to hover between 19 and 21 times earnings. The valuation dropped last year, which was probably what prompted management to buy back shares so aggressively. As long as the stock's valuation remains in this lower range, it seems plausible that large buybacks could continue.
If they do -- or if there's a dividend hike and favorable overall market conditions -- I think T. Rowe Price Group's stock could continue to soar.