Recent Buy: June 17th, 2015
We’re hearing a lot of stock market news about interest rate hikes, the Greek debt crisis, and oil prices. Some investors are saving cash, hoping for a correction or crash to buy stocks at discounted prices, but not all stocks have the same fundamentals or valuations and I believe there are still attractive investments out there. I’ve had a busy June so far contributing $6,653.22 where I see the best long-term values.
It’s true that any number of events could cause short term pain in the stock market, but once I own a company as a dividend growth investor, I don’t really watch the stock price; I only make sure the dividend payout increases each year through the ups and downs of market volatility. Downward stock price momentum is an opportunity to grab even more future dividends in high quality companies for less cost. I absolutely welcome, and even hope for, a crash or correction to keep me even busier adding wonderful businesses to my portfolio.
How overvalued is the current market? It really depends on what metrics you’re looking at, but one of the most common methods is the P/E ratio because stock prices tend to follow earnings over long periods of time. The stock market grows as its businesses and the economy grows. The market is always supposed to be setting new highs, so there’s no need to fear it. I’m invested in a lot of companies that make up the S&P 500 index, and when I look at a fast graph of the index, I see a slight overvaluation compared to earnings. We’re still below the normal P/E of the last 20 years with modest growth ahead. (For those unfamiliar with Fast Graphs, when the black current price line moves into the dark green earnings area it indicates the business is undervalued. Here is a basic demo on how to read fast graphs):
My latest investment adds another asset manager in the financial sector to compliment my large position in Franklin Resources (BEN). On June 17th, I initiated a position in T. Rowe Price Group (TROW). This is a new holding for my portfolio, and I’m now invested in 26 different businesses. I bought 17 shares for $78.82 each with a $6.95 commission for a total transaction of $1,346.89. The 2.64% yield on my purchase adds $35.36 to my 12-month forward dividends for a new total of $2,114.05. My objectives with this investment are faster than normal income growth and a fair amount of capital appreciation to go along with it.
I continue to be slightly over allocated to the financial sector with it accounting for over 23% of my overall portfolio; financials are the second largest sector in the S&P 500 index behind technology. Since I plan to limit technology to under 10% of my portfolio because of it’s unpredictable future, my higher weighting of financials reflects the large array of investment opportunities available there. Here’s what the sector breakdown of the S&P 500 index looked like at the end of May:
Asset managers alone now make up almost 10% of my portfolio which is higher than I’d like; however, I’m just starting my investment accumulation phase and every new purchase brings that percentage down a good bit. Meanwhile, I feel comforted knowing that both BEN and TROW are Dividend Champions with over 25 years of increasing their dividend payouts through all sorts of market noise. There is risk nonetheless, and this point will cover TROW’s operations, fundamentals and valuation.
TROW is a major global investment management company founded in 1937 by Thomas Rowe Price Jr. At the time asset managers generally charged flat commissions for fees, but Mr. Price charged fees based on the number of assets under management, and when the clients prospered, so did TROW. This mutually beneficial fee structure along with a focused and disciplined long-term style of investing is still used to this day. In 1986, TROW became a publicly traded company and has raised its dividend to shareholders each of the last 29 years since. They currently manage over $772.7 billion in assets, serving individuals, financial intermediaries, and institutions. TROW employs over 5,900 associates with offices in 14 countries around the world.
The company is a leader in the mutual fund investment world, currently offering over 75 different investment strategies. Many people think high cost mutual funds are dying with the rising popularity of low cost ETF’s, index funds, and self managed portfolios like my own; however, TROW’s number of assets under management (AUM) has been steadily increasing from $482 billion in 2010, to $746.8 billion at the end of 2014. The AUM fees are the main source of TROW’s revenue and net income so this growing trend is very encouraging. TROW has created impressive results for its clients, which is probably why 86% of those surveyed said they would recommend a one-on-one consultation to a friend or relative.
A $10,000 investment in TROW 20 years ago would be worth $213,791.66 today with dividends reinvested. That’s a change of 2,038% and an average annualized total return of 16.64%:
That’s impressive double digit CAGR growth over a long history, but future rapid growth might not come as easily for a while. Short term noise and volatility is always a possibility, and here’s what management had to say in the 2014 annual shareholder letter:
After several years of very healthy returns from both stocks and bonds, we enter 2015 with more modest return expectations for both asset classes. Our view is that global equity markets will outperform fixed income markets but that absolute return levels will be modest. Whatever the investment environment, your company is well positioned. We have a wide range of investment capabilities and highly talented associates dedicated to meeting our clients’ needs. We remain focused on growing the long-term value of your investment.
TROW has had an impressive and responsible use of cash flow in the last decade continuing its global expansion in North America, Europe, the Middle East, and Australia. They have zero debt which is almost unheard of for any business and makes them incredibly attractive as an investment. They also invest into their own funds for growth and extra incentive to provide top notch performance.
The company shines with its rich dividend history. From 2004 through 2014, the dividend grew from $.48 to $1.76 for a CAGR of 16% and an average dividend growth rate of 16.3%. This doesn’t include the recent 18.18% dividend raise in March of 2015 or the $2 special dividend shareholders received in April. While income growth may not be as strong in the future, I’d be happy with even a third of those percentages:
- Rising Popularity of Alternative Investment Vehicles
- Economic Slowdowns
- Mutual Fund Performances
- Equity and Bond Prices
At first glance, a fast graph shows TROW is currently attractively valued with a blended P/E ratio of 16.8. It’s also undervalued compared to its normal 20 year blended P/E ratio of 22.2:
Aside from fully understanding a business, I try to invest with some sort of total return expectation which helps me understand whether or not the current stock price is trading at a fair value. Using Chuck Carnevale’s precise return strategy, I’ve gained confidence in my moderate capital appreciation objective by estimating the following scenarios:
- Analyst Estimates: This calculation uses S&P Capital IQ data to help us predict a reasonable return:With growth capitalized at a reasonable P/E ratio of 15, we will have witnessed an impressive 11.22% total annual rate of return through 2018. That’s a $26.14 gain in price per share and $9.84 gain in potential prorated dividend income. TROW tends to hit or beat analyst expectations about 75% of the time:
- Historical Compounded Annual Growth Rate (No Analysts): Here, I use the lowest annual earnings growth rate from the last decade which is a 7 year annual return to date of 9.6%:
We see a total annualized return of 8.87% through 2018. This is nice because TROW typically grows earnings much faster than the 9.6% used in the estimate. In comparison, I calculated the 5 year earnings growth rate of over 22%, and it would have produced a stellar 37.26% annualized return through 2018. I’d be happy to land anywhere in that range but am guessing it’ll be toward the low end.
- Most Pessimistic Case: This calculation is based on the lowest normal P/E multiple of 19.9 over the last 3 years:
- Most optimistic Case: This calculation is based on its highest premium normal 8 year PE ratio of 21.9:
I love the thought that this company could exceed all expectations through 2018 and warrant this premium market valuation to provide a total annualized return of 22.84%. My investment would double almost every 4 years at that rate, but I’d still be extremely satisfied with only 60% of that return.
This investment looks set to meet my objectives of faster than usual dividend growth and moderate capital appreciation. I believe TROW is currently trading at a very attractive valuation. Even with my high allocation to the asset management industry I’d like to add more at current prices; or if we’re lucky, even lower. Future results may not be as strong, but I’m excited to watch management adapt and continue to be a leader in an ever growing and changing sector of the market.
What are you investing in lately? What are your thoughts on TROW? A special happy Father’s day to all the Dad’s out there!