TipRanks Quality Dividend Newsletter – Edition #2

Hello and welcome to the second edition of TipRanks’ Smart Dividend – a weekly Newsletter providing you with weekly investment ideas for safe-bet quality stocks that are outstanding dividend payers compared to their peers.

Today’s quality dividend stock recommendation is a less-known technology giant whose research enables semiconductor producers to build the most advanced chips, including those needed for generative AI development. The company we recommend has a wide and sticky customer base, rock-solid balance sheet, superb profitability and capital efficiency ratios – and a higher-than-average for its industry dividend yield; on top of all that, the stock is currently trading below the peer average.

But first, let us delve into a short update on the macro and market developments, which will also help you evaluate the stock we will present next.


Macro & Markets: Turning the Page on the Debt Ceiling; New Focus is Fed’s June Meeting

After a week of nerve-wrenching negotiations, President Biden and House Speaker McCarthy reached a preliminary deal on the U.S. debt ceiling. Hopefully, the framework agreement will be passed by Congress by June 5th, the updated “x-day,” according to Treasury Secretary Yellen, after which time the department will run out of the means to make payments on the country’s debt.

Although the legislation is expected to meet strong resistance from hardliners on both sides of the aisle, the sense of overwhelming urgency is expected to coerce them into reaching an agreement. No one wants to see their name on the list of culprits of a default, which would bring chaos into the financial system, as well as a lot of economic damage and a market crash, on top of national humiliation. So, we believe that there will be an agreement, pushing the can down the road for another two years.

With the risk of default almost cleared, investors can focus on the two main issues of interest at the moment: the Fed/inflation and Artificial Intelligence.

The Federal Reserve is under pressure again: Q1 2023’s GDP growth was stronger than forecast; personal consumption is surging; and the job market is still as tight as ever. Moreover, Core PCE, the Fed’s preferred inflation gauge, rose at a faster-than-expected clip in April, indicating that the price pressures are still running hot despite the central bank’s 5% rate increases in the past 14 months.

All that data is adding up to push the Fed to abandon its previous intention of a pause in their next meeting; the markets are now seeing a 50% chance of a hike. If the FOMC members decide on a pause in June, they may well hike again (and, if data warrants it, by more than 0.25%) in July. The policymakers will be watching the data coming in during the next days, including the payroll numbers, to gauge whether they can afford to let the economy have a breather before they pull the rate lever up again.

Meanwhile, AI continues to fuel a market rally. After the surge of the Tech mega-caps, who invest heavily into AI technology and have seen their stocks rise on the back of investor exuberance after ChatGPT was introduced, now it’s the turn of the chipmakers. Nvidia (NVDA) saw its stock soar to the cusp of a $1 trillion market cap, after the chip giant offered blowout guidance for the current quarter, as the company expects the already-robust demand for AI chips to continue surging.

The AI wave is lifting most of the semiconductor-producing stocks, making their valuations even more unreachable than those of the Tech giants. But the market hasn’t yet fully revealed firms that, in the background, enable the development of cutting-edge chip technology. Thus, there are still undervalued gems to find in the space.

Quality Dividend Stock – This Week’s Top Pick

Without further ado, let’s dive straight into our recommendation for a quality dividend stock for this week.

Lam Research (LRCX) is a global leader in the design and manufacturing of semiconductor fabrication tools. The company produces, markets, and services semiconductor processing equipment used in the fabrication of integrated circuits, specifically in the process steps of etch, deposition, and cleaning, and provides equipment for a broad variety of manufacturing and testing capabilities. Lam is the market share leader in dry etch, a critical step in the chipmaking process, and a global technological leader in wafer fabrication equipment production.

Lam Research is a FORTUNE 500 company headquartered in Fremont, California, with operations around the globe. It was founded in 1980 and is publicly traded on the NASDAQ since 1984. LRCX is a large-cap company with a market cap of above $68 billion, belonging to the Information Technology sector (Industry: Semiconductor Equipment).

LRCX serves chipmakers, helping them create the most advanced, complex, and tiny microchips by offering critical chip-processing capabilities. Lam’s products are sold to semiconductor industry firms in all major geographies; its main customers include Intel (INTC), Samsung Electronics (SMSN), Micron (MU), SK Hynix, Taiwan Semiconductor (TSM), and many others. Basically, Lam serves all the world’s leading semiconductor manufacturers; a wide and sticky customer base gives it a strong competitive edge.

In accordance with its name, Lam is a leader in research, holding almost 20,000 patents globally; the company invests heavily in R&D. Thanks to its research leadership, it has gained vast intangible assets related to equipment design. LRCX’s large client base allows it hands-on knowledge of the problems faced by chipmakers, providing valuable information for research and implementation of additional innovative capabilities and front-line technological solutions.

As a supplier of cutting-edge processing technology to chipmakers, Lam Research is stationed within the Artificial Intelligence (AI) technological supply chain. In addition, the company engages in its own AI application R&D. Its latest study, recently published in the scientific journal Nature, examined the potential for the use of AI in process development for chip fabrication. Lam has been using AI and Machine Learning (ML) at the product layer for their customers’ benefit, as well as in the company’s own operations, such as improving equipment performance and consistency.

LRCX is a financially healthy company, with short-term assets covering both its short- and long-term liabilities. Although Lam’s debt-to-equity ratio isn’t low, at almost 60%, the company’s stellar balance sheet and cash positions render this metric almost meaningless: LRCX has more cash than its total debt; debt repayment is well-covered by operating cash flow, while EBIT well covers its interest payments.

Lam Research’s revenues have been growing at an annual rate of above 15% in the past three years; earnings have risen by an average of over 20% per annum. These numbers are not breathtaking compared to the semiconductor industry’s growth rates, but they’ve been much more stable. Besides, for Lam’s investors, the medium pace of growth doesn’t overshadow its outstanding return metrics.

LRCX’s 12-month TTM Return on Equity (ROE) is an eye-popping 68%, meaning that the company generates 22% more profits for its shareholders than its peers in the Semi Equipment industry, and twice as much as the fast-growing semiconductor producers. Lam’s net profit margins are also much higher than average for its peers. As for Return on Assets (ROA), the company’s return of over 26% is in another league from its industry’s average of 10%; meanwhile, the outstanding Return on Capital Employed (ROCE) of 40% – versus the Semiconductor industry average of 13% – is pointing at very efficient use of capital resources.

Lam Research has an outstanding earnings record: the company’s EPS has beaten analysts’ estimates in each quarter (except for one slip in Q1 2022) since these estimates became available at the beginning of 2019. The latest quarterly results, although they did beat estimates, were quite underwhelming, as a pullback in capital equipment spending by memory-chip makers has pressured Lam’s performance. However, short-term setbacks caused by economic uncertainty shouldn’t be a concern for long-term investors of quality stocks, since a wide moat and a well-run business will eventually adjust to all economic scenarios.

In fact, investors weren’t concerned about LAM, as reflected by the company’s stock performance: LRCX has risen 52% year-to-date, with a 20% increase attributed to the period after the company reported earnings. Investors who have held Lam’s stock for the last five years took home a 210% profit; in the past decade, it has made them a whopping 1,200% return. Despite its great long- and short-term performance, Lam’s stock remains fairly valued at a TTM P/E of 17.5 versus the IT sector’s 24.8 and the Semiconductor industry average of 23. LRCX is trading slightly below its fair value, according to analysts.

Analysts have conflicting opinions regarding the future financial growth metrics and the stock’s upside outlook. However, we believe that the company’s firm position as an essential chip technology development enabler, as well as a surge in demand for cutting-edge semiconductors for AI usage, will let Lam benefit from rising complexity in the chipmaking process and support its further earnings growth. A well-managed and financially sound company like Lam will surely know how to handle the incoming demand and turn it into shareholder profits; which, in turn, will translate into a rise in share price.

Still, stock price appreciation isn’t the main metric for income investors. What’s even more important is that Lam Research has been growing its dividend for the last eight years at a rate of almost 28.4% per year for the last 5 years. Lam’s dividend yield might not seem high at 1.1%, but it’s higher than the average for the Semi Equipment industry (0.9%).

Lam Research began paying dividends in Q2 2914 at $0.18 per share; in the first two years, the company paid dividends thrice yearly, changing the schedule to quarterly dividend payments starting in Q1 2016. Since then, Lam has increased its dividend payments every year, with the cash amount per share reaching its current level of $1.73 in Q3 2022:

With its low payout ratio of 18.1%, LRCX’s dividend payments are well covered by earnings; cash flows cover the dividend payout many times over. The company’s financial data confirms that Lam can continue increasing its dividend as it did in the past half-decade (or even faster), and still be able to continue reinvesting heavily into its business at a high rate of return.

LRCX also returns capital to its shareholders through various share buyback programs. During the first quarter of 2023, the company repurchased its own common stock at an aggregate cost of $582 million; in May 2023 the management approved a $5 billion share repurchase authorization.

Lam Research is rated 9/10 (“Outperform”) by TipRanks’ Smart Score system:

To sum it all up, we can say that LRCX demonstrates financial health, business advantages, respectable growth, and stability in returning capital to shareholders, through both share buybacks and a well-covered and growing dividend. Despite outstanding gains, Lam Research’s stock is still value-priced considering its moat, profitability, and future potential for strong long-term income. As a critical technology provider to the production of the most advanced semiconductors, Lam is well-positioned to take advantage of the AI revolution, which will not only change the world but also bring outsized profits to its partakers.