By Douglas Gerlach
Investsor Advisory Service
T. Rowe Price (Nasdaq: TROW) has a wonderful business that generates tremendous cash flow and delivers a needed service in a high-quality way. The downside is that its stock price movements tend to mirror and magnify changes in the overall stock market. The reason for this added volatility is obviously because T. Rowe Price is one of the largest managers of equity mutual funds and separately managed portfolios. About 74% of its assets under management consist of equity and balanced portfolios, while only about 26% is in fixed income funds.
Assets under management reached a record $510 billion on March 31, although there has been considerable volatility since then. Increases and decreases in the value of customer assets under management affect its revenue and profitability by changing the base on which it calculates its fees. The market will do what the market will do on a short-term basis, but T. Rowe Price finds a way to win positive customer fund flows virtually every single quarter. A couple of years ago, even in the worst bear market in many decades, T. Rowe Price experienced just one quarter of slight outflow of customer funds.
We believe that T. Rowe Price’s consistent success in gaining customer assets is due to its status as a no-load fund family, its steady record of performance, and its freedom from scandals that have rocked the industry from time to time. About 89% of T. Rowe Price funds outperformed their peer group averages over the past five years, and 65% out-performed over the past 12 months.
The scale and profitability of T. Rowe Price’s business is evident in its substantial corporate cash flow. Last year, about 35 cents of every dollar of revenue flowed through to the bottom line after all expenses were paid, including taxes. With only modest need for capital expenditure, free cash flow has ranged between 21% and 28% of revenue over the past three years. This is what some would label as a “cash cow.”
T. Rowe Price has steadily raised its dividend over the years, occasionally bought back shares, and made acquisitions from time to time. As of March 31, it had $1.56 billion of cash and investments on its books, equating to almost half of shareholder equity.
Growth-cyclical stocks like T. Rowe Price can be a little difficult to measure on a Stock Selection Guide. Results are pretty much back to the long-term growth trend after the bear market dip. When current results are not around the trend line, it can be helpful to forecast growth trends on a peak-to-peak basis or trough-to-trough basis.
Our forecast of 15% EPS growth is calculated by looking at its historical results in just this way. Five years of such growth could lead to potential EPS of $5.41. A repeat of the average high P/E of 26.4 could lead to a stock price of 143. The potential total annual return, including its dividend, approaches 21% annually. The downside risk appears to be 29% to 42. The estimated low price represents the typical low P/E of 15.6 multiplied by the last twelve months’ EPS of $2.67.
Investor contact is: T. Rowe Price Group, 100 East Pratt St., Baltimore, MD 21202. www.troweprice.com.
Editor’s Note: Douglas Gerlach is editor of Investor Advisory Service, 711 W. 13 Mile Rd., Madison Heights, MI 48071. Monthly, 1 year, $399. E-subscription, $299. www.iclub.com/IAS
