When it comes to stock ideas, quality is often better than quantity. In other words, doubling down on a good investment can make more sense than buying a new stock simply for the sake of diversification.
That is the case with this month's dividend stock pick: Broadcom (AVGO -0.48%). Last month I named the semiconductor company one of two undervalued dividend stocks. But Broadcom's attractiveness as a dividend stock, even after the stock's 15% gain since my recommendation last month, is worth emphasizing.
Here are three reasons for income investors to bet on this dividend stock:
1. Broadcom has a meaningful dividend yield
With its annual dividend payments per share equal to 3% of its stock price, Broadcom is one of a few high-quality megacap stocks with such a heady dividend yield. The average dividend yield of stocks in the S&P 500 is more than 1 percentage point lower, at 1.8%.
It's worth noting that investors haven't been able to buy Broadcom stock with such a robust dividend yield in previous years. Before 2018, Broadcom's dividend yield was mostly below 2% and often not far above 1%. Investors can thank Broadcom stock's 4% decline over the past 12 months and a 72% dividend increase late last year for this compelling opportunity.
2. Broadcom's dividend will likely see more sharp growth
Another reason to love Broadcom as a dividend stock is because another sharp dividend increase later this year is likely.
It's management's practice to return 50% of its trailing-12-month free cash flow to shareholders through dividend payments. This straightforward policy means that the company's dividend generally tracks the trajectory of its free cash flow -- and free cash flow (cash flow provided by operations less capital expenditures) has been rising at a mind-boggling pace. Broadcom's trailing-nine-month free cash flow is up a staggering 52% year over year, paving the way for another massive dividend increase.
3. The underlying business is thriving
As with any dividend stock investment, investors should look beyond the dividend to ensure the underlying company is healthy. Fortunately, Broadcom appears to be firing on all cylinders.
With 13% year-over-year revenue growth and 21% earnings-per-share growth in its most recent quarter, Broadcom's results came in above consensus analyst estimates as the company benefits from strong data center demand.
Looking beyond revenue and EPS, Broadcom's gross margin increased from 48.2% in the year-ago quarter to 51.7% in the company's third quarter of fiscal year 2018. During the same time frame, free cash flow soared 52% and operating expenses declined 15%.
Broadcom isn't just a solid income investment, it's an all-around good stock.