TipRanks Smart Dividend Newsletter – Edition #6

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

Today’s quality dividend stock recommendation is a company that has been constantly increasing its dividends in the past 19 years, while also returning capital to investors through generous buybacks. The company we are recommending takes pride in a highly profitable business model that has led to positive free cash flows for 26 consecutive years – all of which are pledged by the management to be returned to shareholders.

But first, let’s delve into a short update on the macro and market developments.


Macro & Markets: Too Good to Be True?

The U.S. stock markets have decoupled this year from the economic outlook and the Federal Reserve’s interest rate path, staging an outstanding rally. Moreover, if at first virtually all of the stock market gains could be attributed to just a handful of mega-caps, in recent months the gains have been broad-based, with all of the S&P 500 (SPX) sectors except Energy and Utilities logging in positive performance in the second quarter.

On the one hand, the rally may well continue into the second half of the year, supported by the broadening momentum and the economy’s resilience – as well as the continued strength in Tech and the newfound strength in banks following their successful passage of the Fed’s “stress tests.” If inflation in the U.S. continues to abate, the Fed may even soften its stance towards additional rate increases, further supporting the stock markets.

On the other hand, we are entering the third quarter with increased expectations and very rich valuations. The improving economic data and the bullish momentum in stocks have raised investors’ expectations of companies’ financial performance. As we wait for the reporting season to begin, we are receiving multiple profit warnings, and while the U.S. companies seem to be less affected than their global peers, they are not out of the woods, either. Meanwhile, share valuations now price in the scenario of the economic “soft landing” as the worst possible outcome, which leaves them vulnerable to negative surprises on the economic front, as well as concerning earnings reports and further guidance.

In this uncertain environment, we are thankful for the opportunity to hold on to the stability and certainty of financially sound and cash-rich dividend-paying companies.


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.

Analog Devices (ADI) is an American multinational semiconductor company, which designs, develops, manufactures, and markets integrated circuits (ICs) that leverage analog, mixed-signal, and digital signal-processing integrated circuits used in electronic equipment. These technologies are used to convert, condition, and process real-world phenomena, such as light, sound, temperature, motion, and pressure into electrical signals. ADI is a global market leader in the development of converter chips, which are used to translate analog signals to digital and vice versa. The company also offers data converter products, power management and reference products, and digital signal processing and system products.

Analog Devices manufactures over 75,000 analog and mixed-signal semiconductor products for more than 125,000 customers worldwide in the communications, wireless infrastructure, healthcare, military/aerospace, industrial, automotive, and consumer electronics industries. The company’s products are used in a myriad of applications, ranging from flat-screen TVs to autonomous vehicles, advanced medical systems, and industrial robotics.

ADI’s various industrial application chips are responsible for about half of the sales, with automotive semiconductors providing above 20%, while communications and consumer segments add smaller portions of the company’s revenues. In addition, following a decade of strategic R&D investment, the digital healthcare segment of the company’s product array is expected to increase its weight in ADI, providing further diversification and additional income growth.

About two-thirds of the company’s sales are generated outside of the U.S. With such a wide diversification in terms of geographies, industries, products, and customers, ADI’s revenues are less susceptible to the economic cycles than that of other, more concentrated, producers.

Analog Devices is also one of the beneficiaries of artificial intelligence (AI) technological advancement. Analog semiconductor producers have, until now, largely flown under the radar of investors looking to take part in the AI trades, with most of the attention going to “glamorous” AI chips like those made by Nvidia (NVDA). However, as these producers’ stocks have become prohibitively expensive, markets are beginning to buzz about analog chip producers, as well. ADI’s chips are used to translate real-world data like velocity or sound for computer processing; its devices can be found in sensors and other IOT (Internet of Things) devices that connect computers with the outside world and make cutting-edge tech possible. As the use of AI, from smart homes to advanced medical applications, becomes more and more commonplace, the demand for analog chips will continue to increase.

Analog is a large-cap company with a market cap of $98.62 billion and a global workforce of approximately 25,000 employees. ADI is included in the 2023 Fortune 500 list, which ranks the biggest U.S. companies by revenue. It takes second place after Texas Instruments (TXN) in the global ranking of top analog integrated circuit (IC) suppliers with a 13% market share versus TXN’s 19%. The analog chip industry is far less competitive than the digital one, following years of consolidation; top-ten suppliers hold 70% of the market share.

The company belongs to the IT Sector (Industry: Semiconductors). ADI was established in 1965 and has been publicly traded on NASDAQ since 1983.

The analog IC giant has been paying dividends since 1975; it has raised its dividends for 19 years in a row. In the past 10 years, ADI’s dividend per share grew by a CAGR of over 11%. While many companies in the industry either forgo dividends due to the cyclical nature of the semiconductor business or pay insubstantial dividends, Analog Devices has established an impressive record as a dividend growth stock; it is well on the path to becoming a Dividend Aristocrat in a few years.

Analog pays a dividend yield of 1.7%, versus the IT sector’s average of 1.02%. The company’s low payout ratio of 29.9% is more than sustainable and leaves the company with ample net earnings to invest in its organic and inorganic business growth. Coupled with its stellar finances, the low payout ratio provides for the outlook for continued double-digit dividend growth going forward.

Analog’s focus on returning capital to its shareholders deserves special attention. The company’s management has pledged to return 100% of the free cash flow to shareholders through both dividend payments and share repurchases. Besides almost two decades of continuous dividend growth, ADI has rewarded its investors via generous buybacks. In the trailing 12 months through end-April 2023, the company has purchased back its shares for the amount of $3.5 billion.

The company’s stellar financial health and strong profitability metrics make these investor benefits sustainable and ensure continued dividend and buyback growth. Analog Devices’ net debt-to-equity ratio is just 15.4%, with debt well-covered by operating cash flow and interest payments on its debt well-covered by EBIT. With an EBITDA margin of 53% and net profit margin of 28%, ADI leaves the general IT sector, as well as the more profitable (on average) Semiconductor industry, way behind. Analog’s highly profitable business model has proven resilient throughout different macro environments, generating positive free cash flow for 26 consecutive years.

In its financial results report for Fiscal Q2 2023 (ending on April 30th), the company reported record revenue of $3.26 billion, signifying an increase of 10% year-over-year, and also record earnings per share number, growing by 18% year-on-year. This was the 13th consecutive quarter of revenue growth and the 11th consecutive double-digit EPS growth. The company has always beaten analysts’ EPS expectations with one quarterly exception in Q3 2019.

In the past five years, revenue growth has averaged 20.5%, and EPS growth was 24% p.a. It must be noted, though, that last year’s growth numbers were significantly positively impacted by Analog’s acquisition of Maxim Integrated, an analog and mixed-signal IC design and manufacturing specialist, in a $21 billion mega-deal at the end of 2021. Without the addition, organic-only growth would have been slower. As the acquisition jolt has been mostly absorbed by now, Analog is expected to return to its pre-Maxim steady performance. ADI’s medium to long-term period earnings growth is projected to be in the teens, with continued robust cash flows supporting dividends and buybacks.

However, the current and the next quarter outlook marks a slowdown in performance, driven by weaker demand in Asia, particularly China, which is responsible for about 20% of revenue. The muted short-term outlook has led to some decrease in Analog’s stock performance.

ADI stock has brought its investors over 100% gain in the past five years, outperforming the Nasdaq Composite’s (NDAQ) 79%; in the past three years, Analog has risen 65% versus Nasdaq’s 36%. In the past 12 months, the company’s shares have also outperformed their index, with an increase of 36% versus NDAQ’s 22%. Year-to-date, on the back of the weaker guidance, the tables have turned, with ADI rising 20% versus Nasdaq’s 33%.

Although the company’s stock has reclaimed 13% since the guidance-led decline, it is still about 20% cheaper than its five-year TTM P/E average and 13% less than its Forward P/E average. The resulting ratios are still 8%-9% higher than those of the IT sector; but it must be noted that the sector includes many companies with much less attractive fundamentals and paper-thin profit margins, making them incomparable to Analog Devices. Therefore, we view the current lower-than-average valuation of ADI as a great long-term buying opportunity; besides, its buyback and dividend policy allows for much higher share prices.

Long-term investors will find Analog Devices to be an appealing investment prospect. Further dividend growth is all but assured due to the company’s 19-year track record of continuous dividend hikes, supported by a rock-solid business strategy, a sound balance sheet, and the scale and diversification to endure any downturn. We believe that ADI should be included in income investment portfolios since it is secure and stable and has a promising future.