When it comes to searching for dividend stocks, tech seldom makes the cut. Spare cash is usually reinvested to foster further innovation and growth, rather than being used to reward shareholders with a quarterly payout. Nevertheless, while typically not the home of the stock market's highest yields, a combination of modest payouts now and steady pay raises over time can equate to big returns and big paydays for your future self. When building an income-generating portfolio, don't ignore technology.
1. Broadcom: Semiconductors in high demand
I'll start with Broadcom, the only dividend stock on this list that offers a lucrative payday now (rather than later) with a current yield of 3.8%. This networking hardware giant makes everything from smartphone and cloud computing semiconductors to the software to help manage modern IT infrastructure (the product of several acquisitions in the last few years). As a result, Broadcom's best days of growth are likely behind it, but there's still a lot to like here.
For starters, there's the fact that the semiconductor industry was starting to pull itself out of a cyclical slump at the onset of 2020. Though the pandemic at first appeared to bring the optimism to an abrupt end, the opposite happened. Faced with continuity crises, many organizations have been scrambling to update their technology for the modern cloud era in order to keep operations going. During its fiscal 2020 second quarter (the three months ended May 3, 2020), Broadcom management said it was having difficulty keeping up with the demand for some of its products.
Broadcom will provide an update on its third quarter on Thursday afternoon, but barring any surprises, this will likely remain a slow-and-steady story that is getting some benefit from new networking hardware upgrades. Add in its enterprise software business, and investors should expect an average of low single-digit percentage sales growth over the long term, with free cash flow (revenue less cash operating and capital expenses and from which dividends are paid) growing at an even faster pace. It's on this front that Broadcom has been doing especially well, with free cash generation increasing 21% to $3.07 billion in the last quarter.
In fact, though managing its debt ($45 billion at the start of May) will be key going forward, Broadcom generates more than enough free cash flow to keep those payouts rolling (dividend payments used up roughly half of free cash through the first half of 2020). Trading for 14.5 times trailing 12-month free cash flow, this is a reasonably priced dividend stock for those looking for a quarterly payday.
2. Applied Materials: Ride the semiconductor supercycle
Applied Materials is a similar story to Broadcom's. The year 2020 started off promising as chip and related technologies were showing signs of rallying. But what has ensued took many by surprise -- myself included.
The company reported a 23% boom in its revenue during its fiscal 2020 third quarter (the three months ended July 26). A new era for semiconductors is dawning, driven by more intense computing needs including cloud, massive amounts of data storage, and artificial intelligence. Applied Materials, which makes equipment and develops manufacturing processes for chipmakers, reported surging demand from its customers. It will be a bumpy ride along the way, subject to normal manufacturing fluctuations inherent in the semiconductor industry, but a new up-cycle has begun -- and companies like Applied Materials stand to benefit over the next decade.
Even better than the sales growth, though, is the even faster pace of profit growth. Adjusted net income grew 41%, and similar rates of expansion were forecast for the final quarter of the fiscal year. And as chip manufacturing needs change, Applied Materials has ample room to develop the needed tech and continue paying its current dividend yield of 1.4%. It isn't the biggest payout around by any stretch, but with dividends paid eating up only about one-quarter of free cash flow so far during the current year, this stock is a good dividend increase candidate in the years ahead.
As of this writing, Applied Materials stock trades for 19.2 times trailing 12-month free cash flow. It had $6.29 billion in cash and long-term investments and only $4.29 billion in debt at the end of July. For a company that pays a little now, could pay more later, and is still in long-term expansion mode along the way, I think this is a reasonable value for the long haul.
3. Arista Networks: Cloud networking is the future
If you peeked before reading, you know already that Arista Networks isn't a dividend stock. So why is it here on this list? Because of share buybacks, another form of shareholder capital return.
Rather than pay out excess cash via a dividend, Arista instead purchases outstanding shares (which reduces share count, which in turn boosts earnings per share). Arista temporarily suspended share repurchases in the second quarter when uncertainty was running high, but has committed to buying at least $1 billion-worth over the three-year stretch commencing in the spring of 2019 (nearly half of which has been used up). Currently, with a market cap of $17 billion, it works out to nearly a 6% total return of capital barring any additional future purchase authorizations.
In recent quarters, this share repurchase program hasn't worked out so well -- due to Arista stock struggling as it deals with a slowdown in data center construction from its largest customers. Stock prices have essentially been stuck in sideways action for the better part of two years as the company gears up for another type of hardware upgrade -- data center and networking equipment. Competing with elements of Broadcom, as well as internet equipment giant Cisco, Arista sees an eventual resumption of overall growth as many organizations are long overdue to replace their internal networks with more modern software-defined technology.
In the meantime, Arista sports $2.79 billion in cash, equivalents, and investments and zero debt, and even in difficult times generates operating profit margins north of 30%. It may not be a traditional dividend stock that can help pay the bills right now, but it most certainly could be. Shares trade for 19.5 times free cash flow -- not cheap as sales are in a slight decline so far in 2020, but a long-term value given the potential this disruptive cloud networking hardware company possesses.