Via SeekingAlpha.com

Written by Robert Kovacs

Introduction

T. Rowe Price Group (TROW) has been on my radar for a while now. Over the last few years, I’ve watched it as its dividend fluctuated between 2.5% and 3%, getting tempted when it got closer to the upper boundary, but ultimately never pulled the trigger. As I’ve looked at it again in the past two weeks, my interest has peaked, as has my resolve. I am going to initiate a position in this fantastic dividend stock.

Source: Open Domain

Our investment system has an unforgiving aspect to it. Dividend paying companies have the potential to grow their dividends at a certain rate. Depending on our assessment of this rate of growth, we require stocks to yield a certain amount.

This means that there are times when it is difficult for us to find many great stocks at prices which will make the dividend powerful enough to contribute towards achieving our financial goals.

With many stocks now trading 10-30% lower than they were just 2 months ago, we’re finding opportunities among high-quality dividend stocks. Part of us feels that this market is going to get a lot worse, and that even better prices will appear, yet our system suggests that you should be a net buyer in all markets, until you retire.

This is an approach we have decided to take, because while stock price appreciation has a role in our system – for instance, we sell stocks at a profit with the goal of increasing our income – this role remains secondary. Our system’s goal is to get you enough income to stop having to work for money and to cover all your expenses at the date you decide upon.

So will stocks go down some more? Maybe yes, maybe not. But if you know what needs to be done to reach your goals, you know you should be buying high-quality dividend stocks in all environments.

TROW is currently trading at $98.85 and yields 3.64%. Our MAD Scores give TROW a dividend strength score of 80 and a stock strength score of 75.

I believe that dividend investors should consider investing in TROW at current prices.

Source: mad-dividends.com

It might seem contradictory to invest in an investment management company when AUM is dropping month after month, but TROW has the resilience and pristine balance sheet to see this through, and come out as a leader on the other side.

I’ll present TROW’s dividend profile before considering its potential for capital appreciation.

Dividend Strength

A strong dividend is a safe dividend. I’ve vowed to repeat this in all of my articles, because I want to make sure you all understand this. But a strong dividend is also one which will contribute to you reaching your financial goals by providing the right balance of dividend yield and dividend growth potential. We call this growth/yield couple dividend potential. When you combine dividend safety and dividend potential, you get dividend strength. If you’re interested in knowing how we calculate it, you can read this guide we wrote.

Dividend Safety

TROW has an earnings payout ratio of 35%. This makes TROW’s payout ratio better than 56% of dividend stocks.

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TROW pays 49% of its operating cash flow as a dividend, which is better than 22% of dividend stocks.

TROW pays 56% of its free cash flow as a dividend, which is better than 38% of dividend stocks.

I only will chart the earnings payout ratio below, because of the extreme values in operating cash flow and free cash flow payouts. You can follow them in the table below.

31/12/2015

31/12/2016

31/12/2017

31/12/2018

31/12/2019

Dividends

$2.0800

$2.1600

$2.2800

$2.8000

$3.0400

Net Income

$4.63

$4.75

$5.97

$7.27

$8.70

Payout Ratio

45%

46%

39%

39%

35%

Cash From Operations

$5.96

$0.67

$0.90

$6.58

$6.22

Payout Ratio

35%

318%

251%

43%

49%

Free Cash Flow

$5.36

$0.08

$0.17

$5.89

$5.39

Payout Ratio

39%

2400%

1267%

48%

57%

Source: mad-dividends.com

With the latest numbers, as you can see, the company generates more than enough free cash flow to pay its dividend. In 2016 and 2017, the company didn’t generate enough cash, but still paid the dividend without interruption.

This can be explained by the fact that the company caries no debt. It doesn’t need to service any debt holders; it can focus solely on its shareholders.

The following biblical passage rings true here:

“No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other.”

While I do believe that debt and shareholders can coexist in harmony in a company, one must remember that a shareholder will always be subordinate to the debt holder. Debt holders have seniority when it comes to the lean on cash.

Debt will always be chosen to be paid over the dividend. If the choice doesn’t need to be made, the dividend’s safety benefits. This is why I always ensure that the company has a reasonable interest coverage ratio, as to ensure that interest payments don’t interfere with the ability to pay the dividend.

TROW has no debt. That’s without mentioning that the company has enough cash on hand to pay the dividend for the next two years.

Simply put, TROW’s dividend isn’t going anywhere.

Dividend Potential

Want validation of that last statement?

In April, the company grew its dividend by 18% which is considerably higher than the company’s 5-year average dividend growth of 12%. This speaks loads to management’s conviction that their dividend is safe, and well guarded.

Source: mad-dividends.com

I believe this was management’s main goal when increasing the dividend by so much. I don’t believe it is likely that we will see 15%+ dividend growth for the next few years, but management has shown dedication to averaging 11-12% dividend growth for the last decade. I believe this will keep going for the next few years.

This level of dividend growth is very satisfying when we look at TROW’s current yield.

Source: mad-dividends.com

TROW has a dividend yield of 3.6% which is better than 54% of dividend stocks. Even when TROW yielded 2.5%, many younger investors would have probably had a decent deal purchasing the stock. For me, not so much. I’m getting closer to retirement, and the numbers work against me when I buy stocks with yields below 3%. My sweet spot is 3.5% and up.

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The bottom line is that TROW’s dividend potential is superior.

Dividend Summary

TROW has a dividend strength score of 80 / 100. Superior dividend safety, and superior dividend potential result in a superior dividend strength score. TROW is definitely a stock dividend investors should consider, especially at current prices.

Stock Strength

Now, I believe TROW is very attractively priced from the prospects of a dividend investor. But what are its prospects relative to the market in upcoming quarters? One month ago, Goldman suggested that TROW’s price hadn’t yet felt the full wrath of the upcoming earnings winter.

Thankfully, I don’t rely on any banker in a fancy suit to decide what’s right for my portfolio. God knows where I’d be if I did. Not to say they aren’t right, just to say I don’t listen to their stories.

Rather than listening to bankers’ stories, I’d much rather listen to the stories the numbers tell. And for as long as we’ve had financial markets, the story told is that stocks which have good valuations, good relative momentum, and superior quality will do better than the median stock.

So those are the factors I consider. They then get combined into a stock strength score, which can be understood as the likelihood of a stock doing better than the market in upcoming quarters.

Value

  • TROW has a P/E of 11.36x
  • P/S of 4.30x
  • P/CFO of 15.87x
  • Dividend yield of 3.64%
  • Buyback yield of 0.63%
  • Shareholder yield of 4.27%.

According to these values, TROW is more undervalued than 64% of stocks, which is encouraging. The stock trades at reasonable multiples of earnings and cash flow, and has a good shareholder yield, which will likely only get better, considering management increased the authorization to buy back shares. The company could repurchase 10% of its own stock at current prices under the current authorization.

Source: mad-dividends.com

As you can see, TROW is currently trading below its historical average PE. This shows the expectation of a decline in earnings because of the current situation.

Yet management’s decision to aggressively increase both the dividend and the buyback program sends a strong signal that the company is fully equipped to deal with the pandemic and any fallout.

Relative to the market, TROW offers decent value.

Value Score: 64 / 100

Momentum

TROW trades at $98.85 and is down -25.28% these last 3 months, -10.90% these last 6 months, and -6.66% these last 12 months.

Source: mad-dividends.com

The outperformance the company experienced in the later part of 2019 and early 2020 vanished in February and March. As it stands, its 12-month performance is very similar to that of the S&P 500.

This gives it better momentum than 63% of stocks, which goes to show that as an index, the S&P 500 has better momentum than 2/3rds of US listed stocks. While the going’s been tough for all, small- and mid-caps have been hit harder than many realize.

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TROW, while not a market leader, has held up pretty well. The sort of company we see in TROW’s situation are often those who are not directly benefitting from the pandemic (very few are), but who are well equipped to deal with the pandemic.

Its momentum will likely therefore remain somewhat superior to the median US stock for the coming quarters.

Momentum Score: 63 / 100

Quality

TROW has a gearing ratio of 0.2, which is better than 95% of stocks. The company’s liabilities have increased by 34% over the course of the last 12 months. The company’s operating cash flow can cover 137.5% of liabilities.

Each dollar of assets generates $0.6 in revenue, which is better than 54% of stocks. It depreciates 95% of its capital expenditure each year. TROW has a Total Accruals to Assets ratio of 3.0%, which is better than 10% of companies. This makes TROW’s quality better than 62% of stocks. But this is actually unfair to TROW. Our model isn’t geared to companies which have no debt, because most companies do have some. Therefore, interest coverage has contributed no points to TROW’s score. If it did, then the company’s score would be well above 75.

While this highlights a shortcoming of quantitatively measuring everything, it shows the value in complementing quantitative analysis with common sense and qualitative analysis.

TROW has superior quality. There is no doubt about it.

Quality Score: 62 / 100

Stock Strength Summary

When combining the different factors of the stock’s profile, we get a stock strength score of 75 / 100 which is very encouraging. It goes to show that being just in the best 40% of stocks for each of the 3 factors can land you in the top 25% of stocks at an aggregate level.

It is actually quite rare to see high markers on all three factors. Better than median values for all make a stock quite attractive. TROW has the quality, valuation and relative price strength to do better than the median stock in upcoming quarters.

Conclusion

With a dividend strength score of 80 and a stock strength of 75, TROW is a great choice for dividend investors. You get to initiate a position at a great price; TROW will likely perform better than you require from a dividend perspective, and this will eventually translate into stock gains over time.

I’ll be initiating a position within the next few days.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TROW over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.