The technology sector has become a great place to look for dividend stocks, as the 3.2% average yield offered by companies in this sector is more than double the S&P 500's average dividend yield of 1.5%.
What's more, dividend-paying technology companies offer investors the potential to benefit from fast-growing trends and the associated stock price upside. This is why we are going to take a closer look at Applied Materials (AMAT 2.14%) and Xilinx (XLNX) -- two stocks that are sitting on notable opportunities and trade at very attractive valuations.
Applied Materials could give its dividend a nice hike next year
Applied Materials' 1.65% forward dividend yield might be lower than the technology sector's average, but there's a lot to like about the company. First, the stock has shot up over 50% so far in 2019 despite a muted financial performance lately, which shows its resilience and investors' faith in the company's long-term prospects.
The rally doesn't seem to be misplaced as it is a solid bet on the rise of the semiconductor industry. It supplies chip fabrication equipment to semiconductor companies, so the demand for its products stands to rise in the future on the back of emerging technology trends -- 5G networks, the Internet of Things, artificial intelligence, and autonomous driving, among others -- that will create the need for more complex chips.
The semiconductor industry is going through a lean patch right now, but the company sees a turnaround taking place next year. CEO Gary Dickerson pointed this out on the latest earnings conference call: "Taking these factors into account, our view of overall wafer fab equipment spending for 2019 remains the same down mid-to-high teens on a percentage basis relative to last year. We see 2020 is a more positive set up for the industry in Applied with the start of a recovery and memory investment and sustained strength in foundry logic spending."
The next reason to buy Applied Materials is valuation. Despite the rally, the stock continues to trade at an affordable valuation. Its trailing price-to-earnings (P/E) ratio of 15.7 is lower than the company's five-year average multiple of 18. So, now would be a good time to go long on the stock as a turnaround next year could encourage the company to give its dividend a nice bump.
I'm saying that because Applied Materials had doubled its quarterly dividend payout in early 2018 thanks to a favorable financial performance and its tradition of returning around 90% of the free cash flow back to investors. It has stuck to that tradition despite a fall in its free cash flow over the past year, having returned $724 million to shareholders (share repurchases and dividend payments combined) in the fiscal third quarter when its free cash flow came in at $694 million.
Applied Materials' dividend payout was $196 million during the quarter, which was 27% of its free cash flow. Adjusted net income was $692 million in the third quarter. This tells us that Applied Materials treads on the side of conservatism when it comes to the dividend payout, so it has the space to increase the dividend.
What's more, the recent uptrend in Applied Materials' free cash flow is likely to continue into the next fiscal year thanks to the turnaround that both the company and Wall Street are expecting. Analyst estimates compiled by Yahoo! Finance tell us that Applied Materials' top line could jump 7% next year after a double-digit decline in 2019. Its EPS is estimated to jump from $3 this year to $3.35 next year.
Thus, don't be surprised to see the company give its dividend a bigger bump in 2020 as compared to the 5% increase it announced earlier this year.
Xilinx has a strong record and notable catalysts
Like Applied Materials, Xilinx's dividend yield of 1.64% might not seem remarkable at first, but the company has increased its dividend for eight consecutive years. Xilinx has delivered consistent dividend growth over the past three years, but it has become conservative as far as the payout ratio is concerned.
Xilinx has paid out $367 million in dividends over the trailing 12 months and generated net income of $941 million. What's more, the company's free cash flow generation has been consistently moving north and sits just over $1.1 billion.
The good news for investors is that the company is expected to sustain its bottom-line growth on the back of its market-leading position in the FPGA (field-programmable gate array) market and a clutch of opportunities in the automotive, data center, and artificial intelligence verticals.
However, Xilinx's near-term guidance has been impacted by trade war-related uncertainty as the company had to stop shipments to Huawei in the wake of the Chinese company's addition to the Entity List. Lorenzo Flores, Xilinx's CFO, had this to say on the latest earnings conference call:
At this point in time, we are monitoring the China trade situation and the overall economic environment. Given the uncertainty of -- regarding these important factors, we are not reiterating or updating our full-year guidance today.
Overall, we believe our long-term growth drivers remain very much intact. Although our FY '20 revenue expectations have been somewhat moderated by trade-related concerns, we continue to believe that the second half of our fiscal year will be better than our first half.
Xilinx management's confidence that things will get better isn't misplaced. After all, Xilinx's products are of a mission-critical nature in the semiconductor industry and they have allowed the company to overcome broad market uncertainties in the past. Moreover, Huawei supplies a very small portion -- in the low single digits -- of Xilinx's revenue, so the negative impact of the ban shouldn't last for long given the other catalysts at play.
Not surprisingly, analyst estimates compiled by Yahoo! Finance indicate that Xilinx will be able to sustain its double-digit revenue growth and also deliver higher earnings in the current and the next fiscal years. So, investors can expect Xilinx's free cash flow profile to improve, which could result in further dividend hikes in the future.
Finally, Xilinx's P/E multiple of 24.6 is lower than its five-year average multiple of 27. In fact, now seems like a good time to get into the stock thanks to the recent drop in the price, which has made Xilinx cheaper than before.