Undervalued Dividend Growth Stock of the Week: T. Rowe Price (TROW)

November 2, 2014
By

yield-stockphotoIf you’re looking for a way to smooth out the volatility in the stock market, I have two words for you.

Cash flow.

Once you start focusing on cash flow, the ebbs and flow of the stock market don’t really matter too much anymore.

And that’s a big reason why I personally invest in dividend growth stocks.

You can see for yourself by checking out my personal portfolio anytime you’d like.

I personally own 51 stocks spread across every major sector of the economy.

If agriculture isn’t doing well, then I have Big Oil to rely on.

If oil drops, then I can count on people to continue brushing their teeth.

Even better, all 51 of the stocks I’m invested in send me increasing cash flow regularly via rising dividend payments.

I routinely scour David Fish’s Dividend Champions, Contenders, and Challengers list for possible investment ideas, and that’s because there is more than 550 stocks on this list that have increased their stocks for at least the last five consecutive years.

But I’m not just scouring for any stock on that list. I’m scouring for a deal.

That’s right, I love a good stock as much as the next guy. But that doesn’t mean I’m willing to overpay for it. I want quality, but I want it cheap.

Just like you may check the local paper Sunday for all kinds of coupon goodies on merchandise you already want and/or need, I look for discounted stocks – stocks on sale.

Stocks can indeed be found on sale. This happens when a stock’s sticker price is less than what it’s worth.

And I’m always excited to buy a stock on sale. Just like you might love to score a pair of pants down at the local department store on sale for 50% off, I thoroughly enjoy buying stocks for less than what they should be priced at.

If you’re at all unfamiliar with how price and value interact or interested in learning how to value stocks, check out this tutorial.

I’m always hunting for a good deal. And I think I may have found one here.

T. Rowe Price Group Inc. (TROW) is a holding company, which provides asset management services through its subsidiaries.

This dividend growth stock might fly under the radar, but I don’t think it deserves to be that way.

First, the company has increased dividends for the last 27 consecutive years.

That’s impressive by itself, but even more impressive when you consider the rate at which they’ve increased the dividend; the 10-year dividend growth rate stands at 16.2%. Very nice.

The stock yields 2.18% here, which is above what the broader market offers. And that yield isn’t just backed by the tremendous payout growth, but also by a low payout ratio, at just 39.7%.

So they have pretty excellent dividend metrics, but what about the rest of the company? Well, let’s check it out.

Revenue has increased from $1.277 billion in fiscal year 2004 to $3.484 billion at the end of FY 2013. That’s a compound annual growth rate of 11.8%.

Fairly robust growth here.Capture

Earnings per share grew from $1.26 to $3.90 during this same period.

That’s a CAGR of 13.38%.

Again, very impressive.

And that growth rate doesn’t appear to be slowing down. S&P Capital IQ is anticipating 12% compound annual growth in EPS over the next three years.

Meanwhile, the balance sheet is flawless. No long-term debt to speak of. Few companies manage a fortress balance sheet like that.

And profitability is fantastic. Net margin finished at 29.8% last fiscal year, while return on equity came in at 23.97%.

The fundamentals look great. But no stock is worth paying too high a price for. So what’s TROW worth?

Well, the stock trades hands for a P/E ratio of 18.24 right now. That’s in line with the broader market, but substantially below TROW’s own five-year average. We might be on to something here.

But I wanted to put a number on shares. Let’s actually value the stock and see where come out at.

I valued shares using a dividend discount model analysis with a 10% discount rate and an 8% long-term growth rate. That rate is well below TROW’s own long-term EPS growth and dividend growth. The dividend growth could actually permanently halve and it would still be above what I’m using for this model. The DDM analysis gives me a fair value of $95.04 on this stock.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide. The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth. It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today. I find it to be a fairly accurate way to value dividend growth stocks.

But if you want other opinions – I don’t blame you if you do – I’ll give them to you.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system. 1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value. These stars are meant to coincide with predicted returns, as a stock that is substantially overvalued will likely lead to subpar returns.

Morningstar rates TROW as a 3-star stock, with a fair value estimate of $87.00.

S&P Capital is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line. They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

S&P Capital IQ rates TROW as a 4-star “buy”, with a fair value calculation of $90.10.

If we average all three of these numbers we’re looking at a fair price of $90.71. That means shares could be 10% undervalued here, which is possibly a rare opportunity in this market.

sc (1)Bottom line: T. Rowe Price Group Inc. (TROW) has established an excellent track record of increasing profitability at an impressive rate, conservative management, and rewarding shareholders with substantial dividend raises. The near future looks just as bright as their past, and shares appear 10% undervalued here. This could be an opportunity to buy equity in one of the world’s premier asset managers. Are you ready?

– Jason Fieber, Dividend Mantra

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