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2 Cheap Dividend Stocks to Consider

By Harsh Chauhan – Apr 5, 2018 at 12:06PM

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Garmin and Applied Materials could prove to be solid long-term picks for dividend investors.

It can be difficult finding high-yielding dividend stocks in the technology sector as tech companies are usually reinvesting their earnings to stay ahead of the curve. Not surprisingly, the tech sector's average dividend yield is a lowly 1.25%, so it isn't the ideal place for income-oriented investors.

But then, there are companies such as Garmin (GRMN -1.78%) that offer an attractive yield of 3.43%. The GPS (global positioning system) technology specialist has been paying a dividend since 2003 when it had a yield of less than 1%, over the years it has become an attractive dividend play. This is why dividend investors shouldn't let the likes of Applied Materials (AMAT -2.95%) slip through their hands as it could turn out to be -- from a dividend perspective -- the next Garmin.

Let's take a closer look at why income-oriented investors should keep these two stocks on their watchlist.

Blackboard with doodles drawn and the word Dividend written with chalk

Image Source: Getty Images

Applied Materials

Applied Materials has a puny trailing dividend yield of just 0.68%, but that's about to change very soon. In February, management announced that they will be doubling the quarterly dividend payout to $0.20 per share. This means that the company's dividend yield will rise to 1.36% on a forward yield basis, exceeding the tech sector's average.

But even then, Applied Materials' dividend payout ratio will remain at a very conservative 18% of earnings, indicating that there is a lot of room for growth in the future. More importantly, the company has returned close to 90% of its free cash flow to investors in the form of dividends and share repurchases since 2000, which should give potential dividend investors confidence that Applied Materials would as well as could increase its payout in the future.

In fact, the company's management made it clear over the latest earnings conference call that it will "review our distribution practices on a regular basis and evaluate further dividend increases as we continue to grow the business." This confidence isn't misplaced because Applied Materials plies its trade in a less volatile area of the tech space, and it has been witnessing solid growth in demand for its chip fabrication equipment thanks to emerging technologies.

Demand for chips needed to enable the Internet of Things is estimated to increase at a CAGR (compound annual growth rate) of 15% over the next five years. Automotive chip demand is estimated to increase by 10% a year until 2024. At the same time, chipmakers such as Samsung are looking to capture a greater share of the global foundry market, so the demand for the equipment required to fabricate chips is going to increase.

This bodes well for Applied Materials, and it is not surprising to see why analysts expect its earnings to grow at close to 19% annually for the next five years. Now, the increase in net income should enhance the company's free cash flow, which has already demonstrated impressive growth over the past year.

AMAT Free Cash Flow (TTM) Chart

AMAT Free Cash Flow (TTM) data by YCharts

As Applied Materials has been returning a substantial portion of its free cash flow to investors historically, an increase in this metric means that it could pay a bigger dividend in the long run. Finally, the company's valuation is the icing on the cake. It trades at just 13 times forward earnings as compared to the 28x industry average, this is thanks to the anticipated earnings growth.

So, dividend investors definitely need to closely follow Applied Materials given its cheap valuation and strong dividend growth potential.

Garmin

I have already mentioned that Garmin has a long history of paying juicy dividends, and it needs to be checked if the company is capable enough of maintaining its current yield. Garmin has struggled to substantially grow its revenue and net income over the past year, and this has hurt the company's free cash flow profile.

GRMN Revenue (TTM) Chart

GRMN Revenue (TTM) data by YCharts

Garmin is swimming in rough waters as the demand for its stand-alone GPS systems has eroded in the wake of smartphone-based navigation apps. The company is now trying to transform itself into the broader consumer electronics market by making outdoor and adventure-focused, GPS-enabled, sports watches.

Good news: this strategy is helping Garmin turn around. The company's revenue increased 3% year over year last quarter, its margins improved by 1.5%, and operating income increased 12%. However, the company's investments in new capital assets hurt its free cash flow generation. Garmin's free cash flow in 2017 fell 15% year over year to $521 million.

Still, the company maintained its dividend last year, paying out two-thirds of its free cash flow. This drop in the free cash flow levels could spook dividend investors as Garmin could be forced to reduce its payout. But the company has done the opposite. It recently raised the quarterly dividend by 4%, which brings its forward dividend yield to 3.60%.

This is because Garmin expects its turnaround to continue this year, and forecasts stronger free cash flow generation of $560 million in 2018. What's more, Garmin's bottom line growth is expected to accelerate. Analysts anticipate the company to clock 5.48% annual growth in earnings over the next five years, as compared to the 2.93% annual growth seen in the last five.

Garmin's diversification into the wearables market should prove to be a tailwind, and help it maintain its impressive dividend yield. Finally, its stock is trading at 16 times last year's earnings as compared to the industry average of 34. As such, it could prove to be a solid pick for investors on the hunt for a dividend-paying value play.

 

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Garmin Ltd. Stock Quote
Garmin Ltd.
GRMN
$80.31 (-1.78%) $-1.46
Applied Materials, Inc. Stock Quote
Applied Materials, Inc.
AMAT
$81.93 (-2.95%) $-2.49

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