Business growth and return of excess cash to shareholders is a powerful investment combination that can add up to incredible returns over time. That's why investors looking for income shouldn't ignore tech stocks. Though not known for the highest dividend yields around, the technology sector produces some incredible names that help investors compound their growth and pay some bills along the way. Three worth a look for your dividend portfolio are Lam Research (LRCX 0.17%), OpenText (OTEX -2.96%), and Broadcom (AVGO 0.07%).
A bet on high-end computing, manufacturing, and a chip shortage
Nicholas Rossolillo (Lam Research): This is no household name in the semiconductor industry, but Lam Research is nevertheless a critical player in the world of electronic hardware. Along with peer Applied Materials (AMAT 0.80%), Lam provides chipmakers with the equipment they need to manufacture the building blocks of the digital world. There are hundreds of steps involved in making an advanced semiconductor, and Lam designs the actual machines that do it -- and provides some service and support (about one-third of its revenue) to customers along the way.
Technologies like 5G mobile networks, AI, vehicle autonomy and safety systems, and data centers that support high-end cloud computing require tremendous computational power. Designing the chips that underpin these developments require intensive research in physics, chemistry, and engineering. Lam is thus an indispensable part of technology manufacturing, and new demands from integrated circuits are setting off a new factory upgrade cycle among chipmakers. As a result, this equipment maker is enjoying record sales right now. Revenue was up 54% in the first quarter of 2021 to $3.85 billion, and free cash flow was up 120% to $1.08 billion.
Lam stock currently trades for 23 times one-year forward expected earnings, reflecting the expectation for a continual rapid rise in the bottom line this year as manufacturers upgrade their processes and a global chip shortage has companies scrambling to ramp up production. Sure, Lam is a cyclical business. Once this chip shortage eventually eases and the current upgrade cycle that's underway is complete, sales will reverse course for a time. However, bear in mind that one-third of Lam's business that's tied to ongoing services and isn't tied to cyclical equipment shipments. This is one resilient business with a long track record of making higher highs and higher lows.
Plus, there's just no telling how long the current upcycle will last. Given how important all things electronic have become and with the federal government (and others around the globe) looking to invest in next-gen manufacturing, my gut tells me it could last a while. Lam looks like a long-term value as it rides a wave of technological innovation. And along the way, it pays a decent dividend currently yielding 0.9% a year (which cost the company just $187 million of the $1.08 billion in free cash flow generated last quarter); the remaining free cash flow gets returned to shareholders via stock repurchases. If you haven't done so yet, put this semiconductor industry leader on your watch list.
OpenText: Cash-backed payouts and strong revenue growth
Anders Bylund (OpenText): Data management expert OpenText is a growth story with legs. The company has nearly doubled its annual sales over the last five years while boosting free cash flows by 135%. Dividend payments rose 75% over the same period, keeping the effective yield relatively stable at approximately 1.5%.
This may not be a familiar name to many investors, so here's a quick overview of OpenText's business. The company helps other businesses organize, access, and manage their business data through a combination of cloud-based and on-site tools and services. Along the way, OpenText has acquired market-defining names such as enterprise content manager Documentum and backup systems specialist Carbonite.
OpenText's cloud services are growing quickly, generating a generous stream of subscription-based recurring revenue. Profit margins are expected to widen in 2021, and the company generated $1.1 billion of free cash flows over the last four quarters.
This is one of those fast-growing companies with shareholder-friendly cash management policies that really does give you the best of both worlds -- respectable stock returns and solid dividend payouts. OpenText belongs on every serious income investor's watch list.
One of the highest dividend yields in the space is a rock-solid value
Billy Duberstein (Broadcom): Dividends are not easy to come by in the technology world these days; with all of the exciting innovation going on, the highest-quality tech stocks are generally plowing money back into growth. However, Broadcom Ltd. Is one stock you can buy with favorable growth prospects, as well as a hefty 3.15% dividend yield -- twice the rate of the 10-year Treasury note. What's even better? Broadcom has grown that dividend by 642% over just the past six years -- an increase from $1.94 in 2016 to $14.40 projected for 2021!
Broadcom didn't achieve all of that growth organically, but rather via its business model of accretive acquisitions, mostly within the realm of chips vital to communications applications. Think data centers, mobile phones, Wi-Fi switches and routers, factory automation, and auto chips. In recent years, Broadcom even diversified into infrastructure and security software. Those software businesses, which tend to be steadier and more stable than chips sales, now make up just over 25% of revenue.
While the growth-by-acquisition strategy can sometimes be dangerous -- Broadcom's debt and finance leases have almost quadrupled in that time -- the company has been able to generate hefty cash flows from growing chip demand and solid cost and revenue synergies, and the software additions should smooth out future chip cycles. Currently, Broadcom's dividend is a little bit less than 50% of its free cash flow, so it's not in danger by any means.
Of course, we are currently in a semiconductor shortage as the pandemic has accelerated digital adoption across several industries. That means more semiconductor demand and a strong outlook for Broadcom. Last quarter, chip revenue was up 17% and software was up 5%. While investors get nervous every time there is a boom, I'd still anticipate multi-year strength in the sector, coming off the trade war and pandemic.
At just 17.7 times this year's earnings estimates, Broadcom is also much cheaper than many rivals. That makes it a solid value, and a diversified sleep-well-at-night stock you can own for the long haul, all while reaping a hefty and growing payout.