T price. Rowe (NASDAQ:TROW) has suffered a significant decline over the past six months, falling 37% from the 12-month high of $223.87 on August 31, 2021 to $140.12 today. The combination of falling stock markets and subsequent outflows from mutual funds resulted in lower assets under management (AUM). To make matters worse, TROW is primarily an active management store and the company has suffered outflows as more money moves into passive management. Management expects 2022 to be a weak year.
TROW’s earnings have grown significantly over the past few years, but the EPS growth rate has leveled off and fourth quarter earnings, although slightly above the consensus estimate, appear to have sparked an exit race. If, as many pundits predict, stock returns are weak over the next five to ten years, earnings growth for asset management firms such as TROW will be severely limited. The consensus outlook for TROW’s EPS growth rate over the next 3-5 years is 2.5% per year.
The forward dividend yield is 3.36% and the 3, 5 and 10 year dividend growth rates are 15.6%, 14.9% and 13.3%, respectively. The payout ratio is a very reasonable 33.9% and the company has a 35 year history of increasing the dividend every year. The company obviously has a strong commitment to the dividend. If the weaker growth outlook materializes, maintaining dividend growth rates at levels comparable to recent years will increase the payout ratio. This is sustainable for a while due to the current fairly low payout rate.
I last wrote on TROW on November 8, 2021, when I maintained my bullish overall rating on stocks. At that time, the shares were trading at $221. The shares fell significantly in the following period. When I wrote this article, the consensus outlook among Wall Street analysts was that stocks were a few percent above the 12-month price target at the time and the consensus rating was neutral. . TROW’s strong dividend and proven ability to grow dividend and earnings over several decades was, and continues to be, a reason to bet on this company. In addition to fundamentals and Wall Street consensus, I rely on the Implied Market Outlook, a probabilistic price forecast that represents the consensus view of the options market implied by option prices. In early November, the market’s implied outlook through mid-January 2022 was slightly bullish, although the outlook through mid-April was neutral.
For readers unfamiliar with the implied market outlook, a brief explanation is helpful. The price of an option on a stock reflects the market’s consensus estimate of the probability that the price of the stock will rise above (call option) or fall below (put option) a specific level (the price exercise of the option) by the expiration of the option . By analyzing call and put option prices at a range of strike prices, it is possible to calculate a probabilistic price forecast that best reconciles option prices. This is the implied market outlook. For readers with a quantitative bent who want to understand this approach, I recommend this publication from the CFA Institute. The implied market outlook is not a crystal ball (of course), but provides an additional form of outlook to complement Wall Street fundamentals and consensus.
With TROW falling substantially, as well as broader stock markets, I wanted to revise my analysis.
Wall Street Consensus Outlook for TROW
E-TRADE calculates the Wall Street Consensus Outlook for TROW by combining the views of 9 ranked analysts who have published ratings and price targets over the past 90 days. The consensus rating is neutral, but the 12-month consensus price target is 20.9% higher than the current price. In early November, the 12-month consensus price target was $214.8, so the prevailing sentiment among analysts has become significantly less bullish over the past 4 months. The spread between individual analyst price targets is wide, reducing the overall relevance of the consensus price target as a form of guidance.
Seeking Alpha’s version of the Wall Street Consensus Outlook is calculated by aggregating the price targets of 13 analysts who have updated their views over the past 90 days. The consensus rating is neutral and the 12-month consensus price target is 16.4% higher than the current share price.
The neutral rating and 12-month price target that is 16% to 21% above the current share price is consistent with weak growth prospects and oversold stocks.
Implied market outlook for TROW
I have calculated the implied market outlook for the 4.4 month outlook to July 15, 2022 and the 9.4 month time frame to December 12, 2022. I have selected these two expiry dates to provide a view towards the middle of the year and for the remainder of 2022. The volume of options traded on TROW is low, so the implied market outlook should be given a fairly low weighting in the overall rating.
The standard presentation of the implied market outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
The implied market outlook for the next 4.4 months is skewed towards positive returns and the peak probability corresponds to a price return of +5.25% over this period. The annualized volatility calculated from this distribution is 38%, which is particularly high. In my November analysis, for example, the expected volatility was 27% (annualized).
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution around the vertical axis (see chart below).
This view shows that the probabilities of positive returns are consistently higher than for negative returns of the same magnitude across a wide range of most likely outcomes (the solid blue line is above the dashed red line on the left side of the graphic). This is a bullish outlook for the next 4.4 months.
The theory suggests that the market’s implied outlook should be negatively biased because investors, on the whole, are risk averse and therefore tend to pay more than fair value for downside protection. The expected bias reinforces the bullish interpretation of this implied market outlook.
The implied market outlook through December 15, 2022 shows closely identical probabilities of positive and negative returns (the solid blue line and the dashed red line almost overlap). Given the low trading volume, the most sensible interpretation of this implied market outlook is neutral. The annualized volatility calculated from this distribution is 35%. For reference, E-TRADE calculates an implied volatility of 34% for options expiring on December 15, 2022.
The market’s implied outlook through mid-2022 is moderately optimistic and the outlook through mid-December is neutral. The expected volatility is 38% for the middle of the year and 34% for the rest of 2022.
The expected high volatility of TROW motivates the writing of covered call options on TROW. As I write this, TROW is trading at $138.12 and you can sell a December 2022 call option with a strike price of $140 for $14.20 (this is the price of the ‘offer). The sale of this call option generates 10.3% of option premium income over the next 9.4 months, in addition to the dividend of 3.4%. Selling this call forfeits almost all upside potential, of course, but this is a particularly high level of income.
TROW has seen a sell-off on flattening earnings growth and a weak outlook for 2022. The company’s fundamentals and long-term track record of earnings and dividend growth, however, serve to offset the outlook. short term. The Wall Street consensus indicates that stocks are oversold, with a 12-month price target about 18% higher than the current share price. Typically for a buy rating, I want to see an expected 12-month return that is at least half the expected volatility (34% for the remainder of 2022). TROW meets this criterion. The market’s implied outlook is bullish through mid-2022 and neutral through mid-December. I maintain my bullish rating on TROW but have sold covered calls given the current high volatility.