Analog Devices (ADI -0.57%) hasn't received much love from investors over the past year despite a series of strong quarterly results, and it looks as if the company's latest report isn't going to change anything for the better. The chipmaker's fiscal first-quarter results topped Wall Street's estimates, the current quarter guidance was better than expected, and the dividend was hiked by 7%.
Still, Analog shares fell for no apparent reason after the report was released, and the stock is already underperforming the market this year.
However, investors looking further ahead than the next quarter might find the chipmaker an enticing bet, especially considering its strong dividend history and presence in fast-growing areas like industrial automation and the automotive sector. Let's see why Analog Devices could be a good bet for both income and growth.
Analog has consistently raised its dividend
Analog's latest dividend hike marks its 15th increase in the past 14 years. The company will now pay a quarterly dividend of $0.48 per share, up from the prior payout of $0.45 a share. After this increase, Analog sports a forward dividend yield of 2.13%, substantially higher than the 1.27% industry average.
More important, Analog Devices' payout ratio is in safe territory. The company had paid out 36% of its free cash flow in fiscal 2017 in the form of dividends. And Analog's free cash flow generation has been improving lately. Last quarter, the chipmaker's free cash flow increased close to 11% year over year. It should be able to boost this metric further thanks to robust bottom-line growth, which will eventually lead to a stronger dividend payout.
Analog's net income increased 23.5% year over year on the back of a 54% jump in the top line during the latest quarter. The massive jump in the chipmaker's top and bottom lines was driven by the acquisition of Linear Technology, which was completed last year. This acquisition is crucial in expanding Analog Devices' addressable market across several verticals, paving the way for strong net income growth in the coming years. Let's see why.
Long-term growth seems secure
Analog Devices is targeting fast-growing niches in the semiconductor space. For instance, the automotive business could be one of the biggest growth drivers for the chipmaker thanks to a huge addressable opportunity.
Analog currently gets 17% of its top line from automotive, with total revenue from this segment estimated at $900 million annually following the Linear Technology acquisition. But there's a lot of money to be made in the space as the semiconductor content in each vehicle is expected to grow to $600 in 2025 from $250 today, thanks mainly to the advent of autonomous driving, electric vehicles, and more electronic features inside each car.
The electrification of cars is expected to boost Analog's addressable market by $1.5 billion over the next eight years, with self-driving vehicles creating an additional $3 billion opportunity. The company's legacy automotive business is growing in the high single digits, while the portion inherited after the Linear Technology acquisition is showing growth in the low single digits.
However, the Linear side of the business is expected to record high-single-digit growth in the coming quarters as the synergies of the acquisition come into play. For instance, the combined company will now be in a better position with battery management systems (BMS) opportunity, which have been a sore spot for Analog.
As it stands, Analog expects double-digit growth in BMS sales this year, which bodes well as this market could clock annual growth of 20%. Investors, however, might question the company's valuation as it trades at an expensive 43 times last year's earnings, which is significantly higher than the 35.8 industry average.
But investors need to take into account that Analog recorded a $691 million one-time charge related to the new tax law last quarter, otherwise its P/E ratio would have been lower. The stock trades at a much more reasonable 15.7 times forward earnings, indicating strong earnings growth going forward.
Analog Devices seems like a good bet for investors looking for growth at a reasonable price. The company's business could substantially improve as it is targeting lucrative markets such as automotive. Investors should look past Analog's muted performance on the stock market, as it has bright long-term prospects, and will reward investors with a nice dividend as they wait for the rally to start.