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Analyzing T. Rowe Price’s Dividend Growth Potential

Recap From May’s Picks

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On a price return basis, the Dividend Growth Stocks Model Portfolio (-2.4%) underperformed the S&P 500 (+2.0%) by 4.4% from May 27, 2021 through June 28, 2021. On a total return basis, the Model Portfolio (-2.0%) underperformed the S&P 500 (+2.0%) by 4.0% over the same time. The best performing stock was up 7%. Overall, four out of the 30 Dividend Growth Stocks outperformed the S&P 500 from May 27, 2021 through June 28, 2021.

The methodology for this model portfolio mimics an All Cap Blend style with a focus on dividend growth. Selected stocks earn an attractive or very attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This model portfolio is designed for investors who are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.

Featured Stock From June: T. Rowe Price Inc. (TROW)

T. Rowe Price Inc. (TROW) is the featured stock from June’s Dividend Growth Stocks Model Portfolio.

T. Rowe Price has grown revenue by 10% compounded annually and net operating profit after-tax (NOPAT) by 14% compounded annually over the past ten years. More recently, the firm has grown NOPAT by 15% compounded annually over the past five years. The firm’s trailing-twelve-month (TTM) return on invested capital (ROIC) sits at 36%, which is greater than the company’s average ROIC of 25% since 2010.

Figure 1: T. Rowe Price’s NOPAT And Revenue Since 2015

Steady Dividend Growth Supported by FCF

T. Rowe Price has increased its regular dividend in every year for the last eight years and from $2.36/share in 2012 to $3.60/share in 2020, or 5% compounded annually. The current quarterly dividend, when annualized, equals $4.32/share and provides a 2.2% dividend yield.

More importantly, T. Rowe Price’s strong free cash flow (FCF) supports the firm’s growing dividend payments. T. Rowe Price generated a cumulative $5.0 billion (11% of current market cap) in FCF while paying $3.4 billion in dividends from 2016 to 2020, per Figure 2. In the TTM period, T. Rowe Price generated $1.5 billion in FCF and paid $883 million in dividends.

Figure 2: Free Cash Flow vs. Regular Dividend Payments

Companies with FCF well in excess of dividend payments provide higher quality dividend growth opportunities because I know the firm generates the cash to support a higher dividend. On the other hand, the dividend of a company where FCF falls short of the dividend payment over time cannot be trusted to grow or even maintain its dividend because of inadequate free cash flow.

TROW Has Upside Potential

At its current price of $204/share, TROW has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects T. Rowe Price’s NOPAT to permanently decline by 10%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 14% compounded annually over the past decade.

Even if T. Rowe Price’s NOPAT margin falls to 33% (10-year average compared to 47% TTM) and the firm’s NOPAT grows by just 5% compounded annually for the next decade, the stock is worth $251/share today – a 23% upside. See the math behind the reverse DCF scenario.

Should the firm grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in T. Rowe Price’s 2.2% dividend yield and history of dividend growth, and it’s clear why this stock is in June’s Dividend Growth Stocks Model Portfolio.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in T. Rowe Price’s filings:

Income Statement: I made $252 million in adjustments with a net effect of removing $197 million in non-operating expenses (3% of revenue). See all adjustments made to T. Rowe Price’s income statement here.

Balance Sheet: I made $390 million of adjustments to calculate invested capital with a net decrease of $251 million. The most notable adjustment was $61 million (1% of reported net assets) in deferred tax assets. See all adjustments to T. Rowe Price’s balance sheet here.

Valuation: I made $1.5 billion in adjustments, all of which decreased shareholder value. The most notable adjustment to shareholder value was $1 billion in minority interests. This adjustment represents 2% of T. Rowe Price’s market value. See all adjustments to T. Rowe Price’s valuation here

Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

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