T. Rowe Price: Rough Seas Today Provide Good Dividend Returns Tomorrow (NASDAQ:TROW)

Thesis

As a dividend investor, the goal is to invest in firms that have a high likelihood of maintaining growing dividend payments throughout the investor’s lifespan. T. Rowe Price is a dividend Aristocrat and is likely to continue its growth as a strong capital allocator in an industry that will grow with the economy. All else being equal, analyzing the historical data of T. Rowe Price Group, Inc. (NASDAQ:TROW) shows strong dividend growth and a high probability of future success for investors through quantitative analysis. TROW also has a strong balance sheet and high profitability metrics to support its investors through difficult times. The current “Rough Seas” and cyclical nature of TROW pricing create buying opportunities for investors who can focus on the long-game. The current pricing places TROW at a “Buy” rating with a nice margin of safety for upside potential assuming they can maintain their dividend growth even more modestly than they historically have.

Negative Price Action

TROW price action has moved sharply down more than the S&P 500 over the past year with strong negative momentum (Figure 1). This has been primarily due to its decreasing Assets Under Management (AUM) which is obviously a concern for TROW investors since the revenue is based largely on their advisory services and the value and composition of the AUM. Observably, market conditions create cyclicality for TROW as investor sentiment potentially drives AUM downwards.

For long-term focused investors, this current price action creates optimal buying opportunities for position strengthening or establishment for their portfolios.

Intent

The intent of this article is to value TROW for long-term dividend focused investors. Investors can utilize quantitative methods augmented by investor expectations to determine a purchase price for firms that have a high likelihood of success which create opportunistic purchase points during downtrends.

The utilization of historical data helps investors understand how TROW has performed over a longer period of time. Combining this with a Monte Carlo simulation allows for a virtual representation of future outcomes. The Monte Carlo simulation for this analysis is performed by creating a random sample of 5,000 data points based off historical inputs and predicting what a randomized future may look like for TROW investors. When quantitative analysis is combined with individual investor analysis of TROW’s competitive landscape, management, and other financial metrics, investors can determine where they think the valuation lies for their expectations and factor in a margin of safety for their investment.

Focusing in on the Dividend

TROW has a strong dividend history, and the Seeking Alpha Dividend Grades shows a strong rating for Dividend Safety, Dividend Growth, and Dividend Consistency primarily due to the consistent above average growth rates and well covered payout ratios (Figure 2). The Dividend Yield [FWD] is currently 4.88%, which is higher than the Financial Sector median of 3.22%. This strong historical performance signals that the company maintains a keen eye on shareholder returns.

The Dividend Statistics

The first step in modeling the future dividend of TROW is to analyze their historical performance (Figure 3). The dividend data in this analysis was sourced from the TROW dividend history on the firm’s website and is an important tool for analyzing future scenarios. The historical growth rate distribution shows a strong dividend growth rate since 1986. The mean and median dividend growth rates are 22.24% and 18.3% respectively. The standard deviation is 23.99% with a 95% confidence interval between 30.36% and 14.12%. This means that 95% of the historical data should fall between those values and the standard deviation represents a range of outcomes as a measure of volatility.

It’s important to note that a few large years of high growth rate create a “fat-tail” or skew to the right side and it is less probable that these right-skewing growth rates will continue into the future.

A line graph of the annual dividend (blue line), and the dividend growth rate (red line) since 1986 show what spectacular dividend growth rate changes TROW has supplied to their shareholders (Figure 4). Observe how the greatest growth rate was prior to 1995 and TROW has had much more modest (but still exceptional) dividend growth rates since then.

Monte Carlo Simulation

The Monte Carlo simulation attempts to create randomized future scenarios which can be used to predict future performance. The Monte Carlo simulation for TROW inputs the median and standard deviation from the historical data. The median is chosen because in distributions with skew, the median is a better representation of the truer middle. The Monte Carlo simulation was run through 5,000 iterations and the results show that a forecasted median and mean (17.78% and 17.85%) dividend growth rate can be potentially expected into the long-term future (Figure 5).

The simulation shows that during any independently given year, TROW has a 77.78% probability of increasing their dividend by a positive value. It also shows that at any given independent year, TROW has a 54.92% probability of increasing their dividend by at least 15%. What this means for investors is that using the inputs from the historical data and 5,000 randomized iterations, TROW has a high probability per independent year of having a positive growth rate going into the future. TROW also has a possibility of having a dividend cut during any given year largely due to the large standard deviation in the data. It is important not to rule out the possibility of left tail (Black Swan) events that have negative outcomes for investors and investors should prepare for these by utilizing margins of safety in their inputs.

Growth Rate Summary

Figure 6 represents a summary of TROW’s dividend growth rates that investors can use to form their inputs into their investments. It represents how by utilizing different calculations, investors can determine different formulations for their cash flow perpetuity formulation. The Scenario median growth rate was calculated earlier using Monte Carlo simulations with a value of 17.78%.

The Compounded Annual Growth Rate [CAGR] formula can also be utilized over different time periods to show potential trends (Figure 7). A CAGR formula considers the annual growth with a beginning and ending period and is a more accurate way of measuring returns. The summary above shows the results of a CAGR calculation since 1986, and the past 20, 10, and 5 years. This summary shows that TROW has done a good job maintaining their dividend growth across multiple calculations and periods, which helps build confidence for investors.

Sensitivity Analysis for Dividend Investors

The next step is to determine how investors can utilize this information for determining a purchase price based off their expectation of returns or their expectation for growth. A Gordon Growth Model can determine the intrinsic value of constantly growing payments (Figure 8). We can then utilize a Sensitivity Analysis combined with the Gordon Growth Model to determine purchase prices (Figure 9). It utilizes a constant cash flow (dividend), an expected growth rate (shown in the dividend growth rate summary, Figure 6), and the investors expected return to derive a purchase price for a position.

Orienting and understanding a Sensitivity Analysis is useful for investors to determine their ideal purchase price (Figure 9). The left column shows a scale of different Dividend Growth Rates ranging from 2% to 15%. The Desired Return shows a scale of different investor return expectations ranging from a 5% to 17% return. The tabulated data shows the purchase price of TROW stock needed given an expected dividend growth rate and the investors desired return. As of this writing, TROW is trading around the $106 price range and prices within 5% are highlighted in green.

When an investor utilizes the sensitivity analysis and two of the three assumptions, they can determine their purchase price as demonstrated in Examples 1 through 3 below.

Example 1

If an investor utilizes the Monte Carlo simulation and expects a median growth rate of 17.78% and subsequently adds in a conservative margin of safety and rounds down to a 10% growth rate, then (at the current price) that means the investor can expect a return of approximately 15% if the 10% growth rate is actualized into the future.

Example 2

If an investor utilizes a 10% desired return and thinks that TROW is only going to have a 5% dividend growth into the future (very conservative given historical performance), then that investor would need to purchase around the $100 price range given the assumptions they determined.

Example 3

If an investor theorizes that it is unlikely that TROW could grow their dividend as they have historically and forecasts a 3.5% dividend growth rate for perpetuity, then the current pricing of TROW would create an approximate 8% to 9% return for perpetuity. This example is very conservative and creates a likely return of 8% as a base while creating opportunity for upside returns for any year that TROW grows their dividend at a higher rate. This is a highly conservative estimation but creates a margin of safety for investors’ expectations.

Sensitivity analysis allows for an investor to utilize their choice of the potential dividend growth outcomes and their expected return to determine their buying price and removes behavioral aspects encouraging better investment decisions.

Risk

There is currently large uncertainty and volatility in financial markets. Utilizing quantitative methods for investment decisions is intended to help mitigate risk. The Sensitivity Analysis shows that as the growth rate declines given a constant return expectation, the purchase price decreases for TROW. In times of exceptional uncertainty and risk (present economic conditions), it is beneficial to increase the return expectation or decrease the expected growth rate as a way of factoring in a margin of safety. As an example, an investor who normally expects a 10% return may expect a 15% return as a Margin of Safety and change their purchase price accordingly. Dividend investors can specifically focus on decreasing their risk by increasing their return expectation and estimating future dividend growth conservatively.

TROW specifically has had a large dividend focused outperformance throughout its history. Utilizing the dividend data exclusively could create scenarios that are too optimistic and investors should consider multiple scenarios before making any decision (as demonstrated in Examples 1 through 3). Investors should also consider other financial metrics, management, and competitive landscape to determine whether TROW can continue to grow its dividend at such a superb rate.

The current downward momentum is also concerning for investors that may be interested in TROW price. Current economic forecasts have increased the probabilities of an upcoming recessionary period so maintaining “dry powder” may be important for building a portfolio. Utilizing option strategies like selling cash-secured puts for TROW can provide good short-term returns for collateral cash and strengthen an investors position at different price points if the downward movement continues.

Summary

As a dividend investor, the goal is to invest in firms that have a high likelihood of maintaining growing dividend payments throughout the investors lifespan. TROW is a strong firm with a growing historical dividend that maintains a good balance sheet (negative net debt) and strong profitability metrics. They manage a significant amount of assets and provide opportunity for shareholders to strengthen positions in cyclical market periods (rough seas). Analyzing the historical data of TROW shows strong dividend growth and a high probability of future success for investors through quantitative analysis. Bearish markets and cyclicality provide opportunity for long-term focused investors and TROW can be a nice addition to long-term focused portfolios.