Thesis
After many quarters of declining AUM, T. Rowe Price (NASDAQ:TROW) is beginning to see a rebound in this metric. The stock appears to be attractively valued and could have significant upside depending on what path the market takes over the coming years.
The Backdrop
In our previous article about T. Rowe Price we focused on their consistent track record of growing earnings and increasing their dividends, all while maintaining a pristine balance sheet.
The company has a strong fundamental track record over the long-term, however there have been many sharp share drawdowns over short periods of time.
Due to the nature of their business model, T. Rowe is leveraged to how markets perform in aggregate. The higher asset values are, the higher their AUM is. This leads to an increase in the amount they earn through fees on their asset base. When equity markets are increasing they also benefit from non-operating income in the form of gains on their investments.
AUM Rebound
Over the course of 2022 T. Rowe Price experienced a sudden decrease in AUM, mainly due to declines in global equity and bond markets.
T. Rowe Price Earnings Release Supplement
This decline in AUM has in turn led to a decrease in their operating earnings. The downward trend in operating income was stabilized in Q1 of 2023 mainly through a decrease in operating expenses quarter over quarter.
T. Rowe Price News Release
The most important financial metrics for investors to focus on is their average and ending assets, along with their investment advisory effective fee rate. These metrics sum up their asset base and their ability to monetize that asset base. We can see that while all of these metrics are worse than the comparable period last year, they are all better than Q4 2022. This is a good sign and means that T. Rowe is stabilizing their business. This is especially relevant considering the turmoil in regional banks, and shows that T. Rowe may have even been a beneficiary of that turmoil.
The Path Forward
The reality is that much of the reason for T. Rowe’s rebound in AUM is due to the rebound in equity markets as a whole. No matter how well T. Rowe runs their business, at the end of the day they are at the mercy of forces outside of their control.
That being said, the company appears to be attractively valued even if equity markets stall out at these levels for the foreseeable future.
The company earned $1.83 per share in their most recent quarter (diluted EPS). Annualized out that results in a PE ratio of 14.38 at current prices. This represents a discount to the PE of both the S&P 500 and Nasdaq 100. The company could see tremendous upside to their earnings if markets rebound anytime soon, and in such an event shares would most likely be cheap at these prices.
Price Action
Shares are now trading at around where they were five years ago. While this investment has probably been a disappointment for those over this five year timespan, as we saw earlier the company’s shares have generally increased over the long-term.
This long-term increase has been fueled by management’s ability to consistently grow earnings and return capital to shareholders in the form of dividends and buybacks. Anything can happen in the short-term, but over the long-term stock prices generally track the fundamentals of the company. T. Rowe Price has done well to show fundamental business growth and has survived many difficult environments, and it seems likely that they will survive and eventually rebound from this current difficult environment as well.
Valuation
The company is trading around their long-term average PE ratio. The stock tracks pretty well to earnings expansions and contractions, and investors who are bullish on the broader equity market can use the current price weakness as an opportunity to accumulate shares. Likewise, if an investor is bearish on broader equity markets they may want to stay away from shares of not only T. Rowe Price but any similar asset manager as well.
Whichever direction equity markets go from here, shares in T. Rowe Price will likely move an order of magnitude greater in either direction. Long-term investors can collect the reasonable 4.58% dividend yield while they wait.
Risks
As with any asset manager of this type, T. Rowe Price is at risk of major declines in equity and bond markets. The stock moves more than the overall market in either direction, and a sharp drop in equity markets could lead to an even sharper drop in shares of T. Rowe Price. That being said, investors can collect the dividend and could use any further weakness as an opportunity to buy additional shares.
The risk of asset flight appears to be low, however turmoil at regional banks make it a greater than normal possibility. Asset flight would severely damage their earnings potential and could pose an existential risk to the firm. We view this as being low probability but something that could happen in a period of financial instability.
We believe that the risks are relatively mild here, and that the risk/reward is favorable. T. Rowe Price is our favorite asset manager at the moment, but we would caution investors from allocating too much capital to the sector. The violent swings are unwelcome by many investors, but those that can weather the storm could see significant upside once equity markets eventually enter their next bull run.
Key Takeaway
We view the risk/reward as being favorable and valuation compelling at these levels. The company has started to control costs and stem AUM declines, marking the start of a potential rebound in the stock. Long-term investors who are bullish on equity markets can use this as a way to gain beta to an eventual bull run in equities.
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