I was thinking about the GT Advanced Technologies announcement earlier this week when my mind drifted to some of the truly excellent businesses that have been able to deliver growth this past decade without adding debt to make investments or repurchase stock. That’s not necessarily a bad thing—if your company can take on debt at 1%, 2%, 3%, or 4% interest rates, and if the stock is trading at a price that is less than what it would fairly be worth, it can make long-term shareholders richer than they’d otherwise be if you didn’t do the buyback.
However, I’ve always had a soft spot for companies that are able to deliver high long-term growth without taking on debt—it provides clear evidence that you’re dealing with a company that possesses strong natural growth tendencies when the growth happens without any financial engineering. In the case of T. Rowe Price, there is a lot to like: (1) the company has no outstanding debt, (2) it has no pension obligations (this surprised me), (3) no preferred stock outstanding, and (4) $3.4 billion in corporate cash on hand.
From what I can tell, it’s a company that doesn’t get mentioned much by other dividend writers. I suspect the reason for this is threefold:
First of all, the starting dividend yield tends to hover around the 1.0% to 2.5% mark. Especially during the 1990s when the dividend yield was closer to 1%, there wasn’t much initial appeal to income investors on an introductory basis: Specifically, why would an income investor buy T. Rowe Price yielding 1.3% when he could buy a 30 Year U.S. Treasury Bond yielding 6.89%, as was the case in January 2000?
Secondly, some individual investors have a somewhat hostile attitude towards the mutual fund industry, particularly when they find examples of funds charging 1-2% to deliver returns that lag a basic S&P 500 Index Fund.
And thirdly, there is a small element of cyclicality to the company’s profits—because the company relies on fees generated from assets under management, the company’s profits tend to go down when the economy goes down. For example, T. Rowe Price saw its corporate profits fall from $2.40 per share in 2007 to $1.65 in 2009. Though, to T. Rowe Price’s credit, they manage their dividend policy effectively during good years so they can give larger than expected dividend increases during bad years, as the dividend payout went from $0.68 in 2007 to $1.00 per share in 2009.
Let’s examine the counterpoints to these concerns:
The current dividend yield offered by T. Rowe Price is 2.3%, which is pretty close to the high of 2.5% it achieved throughout the 2009 calendar year. Furthermore, it has a dividend growth rate that offsets its low starting yield—the longer you hang around, the better the amount of income you receive on your initial investment. Over the past ten years—the dividend payment has gone from $0.40 per share annualized in 2004 to $1.76 in 2014. The midpoint of the stock’s 2004 price for the calendar year was around $25 per share; if you did not reinvest the dividends and chose to spend them along the way, your invested principle went from yielding 1.6% in 2004 to 7.04% in 2014.
It took ten years to get there, but you received an additional prize for your years of patience: The price increased from $25 to $75 over these last ten years. Every dollar invested now represents three dollars of market value. Not only have you acquired an ownership position in a business that is increasing its cash payouts to owners at a double-digit rate, but you also acquire a large capital gain for when you decide to sell that sweetens the process for those who take the route of delayed gratification that is inherent in the “low dividend yield but high growth rate of dividend payout” universe.
For those who feel unusual contemplating an investment in the mutual fund industry, it’s important as an investor to recognize when your own perceptions are out of step with the rest of society. At the very least, it’s a successful investor and human attribute to have the self-awareness to recognize when your viewpoints are shared by broader society in general and when they are not. You don’t want to go through life like the Yale professor who was shocked that Nixon beat McGovern because “she didn’t know anyone who voted for Nixon.” Otherwise, you set yourself up to receive the undesirable consequences of misjudgment when you act upon a reality that does not exist.
The fact is, there are many 401(k)’s administered by T. Rowe Price or consist of T. Rowe Price funds, and there are a lot of people in the world who make a lot of money by doing what they love, but don’t have the passion to develop the skillset necessary to make individual investment selections. In the past two years alone, T. Rowe Price has seen its assets under management increase from $576 billion to $692 billion.
Even at the low point of the 2009 recession, the firm still made $433 million in total profits. When a finance firm remains profitable during the second-worst financial crisis in the past century, it strikes me as a solid long-term candidate for investment. You may disagree, and you will make a lot of money if you stick to Johnson & Johnson, Colgate-Palmolive, and Nestle, which virtually never experience more than moderate declines in annual profit—each January, you can usually review the past year and see that your shares are generating more profit than the year before.
That being said, T. Rowe Price does offer some countervailing advantages for those of you who choose to accept the occasional fluctuations in reported profits. The dividend at T. Rowe Price is well managed; it has increased for 27 years straight, due in no small part to the management decision to keep the payout in the 25-40% of profit range during prosperous years, so that, when the 2008-2009 type of situation emerges, shareholders can continue to receive an increasing stream of cash (which, if reinvested, is one of those wealth-creating acts that you realize years later).
Furthermore, in exchange for tolerating about two downward spikes in profits per generation, you receive a better growth rate over the full business cycle. Specifically, in the past ten years, T. Rowe Price shareholders have seen earnings increase at a clip of 15.5% per year, and that is because corporate profits have grown from over $300 million to over $1 billion in the past ten years.
I would think that investors buying today would probably do very well paying $75 per share, though, like everything else, it’s not on sale. It wouldn’t be historically cheap until it hit the low $60s, based on current profits (though, as the company becomes more profitable, the price at which T. Rowe Price becomes a steal also increases). It seems to fall into that category of excellent satellite holdings. Once a person builds up a position of two or so dozen top-tier quality firms, T. Rowe Price becomes an attractive investment consideration when you ask yourself the question, “Okay, what’s next?”