We use analog semiconductors, or chips, every day, even when we aren't aware of it. If you drove a car today, you probably used several analog chips. Watch TV on a flat-screen device? It had analog chips. From advanced medical systems like robotic-assisted surgical systems and CT scanners to home thermostats, analog chips bridge real-world data with many electronic and digital devices.
It's this presence in so many of today's devices and the booming demand for these chips to be added to other devices that has Analog Devices' (ADI 0.64%) management seeing growth accelerating to 7% to 10% compounded annually for the next several years.
Analog Devices generates plenty of passive income
Analog Devices' products are popular and that has been good for the company's bottom line. The company's free cash flow leaped by 30% in fiscal 2021 from $1.8 billion to $2.4 billion (see chart below) and this could be the start of a secular trend.
Data source: Analog Devices 2022 Investor Day report. Chart by author.
Another recent event should also contribute to a growing bottom line. Congress has just passed the Chips and Science (CHIPS) Act, which will provide $52 billion in incentives to semiconductor producers to boost manufacturing in the U.S. Any of this money that makes its way to Analog Devices will increase free cash flow and ultimately flow to shareholders.
All that free cash flow has helped Analog Devices raise its dividend annually since 2004. It paid $0.04 per share that year and is on pace to pay $3.04 per share in 2022. The dividend has gone from $0.48 per quarter in 2018 to its current $0.76, an impressive 12% compound annual growth rate. The company forecasts a free cash flow margin of 34% to 40% on its growing revenue stream, which is terrific news for shareholders. And Analog Devices plans to return 100% of this free cash flow to its investors through dividends and stock buybacks.
Analog Devices has less recession risk than competitors
Some investors are rightfully concerned that a slowdown in the economy could affect consumer spending and end up hurting semiconductor stocks as well. Semiconductor stocks like Nvidia and Intel are trading down 47% and 34%, respectively, from 52-week highs based largely on these concerns. But Analog Devices is only off its 52-week high by about 10% because its business relies less heavily on consumer devices. In fact, only 14% of its sales come directly from consumers (see chart below).
Data source: Analog Devices 2022 Investor Day report. Chart by author.
Analog Devices has over 75,000 products, and its sales are incredibly diversified. This combination makes the company better able to withstand a recession.
With a market cap of $89 billion, Analog Devices trades at 18.5 times forward earnings and 7.5 times forward sales. Analog Devices' market cap could increase 50% in five years by hitting the midpoint of its growth target and still trade for the same sales multiple-plus, and investors get to pocket or reinvest the growing dividend.
ADI PS Ratio data by YCharts
With a forward price-to-earnings ratio of 19 and a price-to-sales ratio of 8.6, Analog Devices stock trades at historically high rates right now. But the future potential for the company justifies the premium stock pricing. Analog Devices could make a terrific portfolio addition for dividend growth investors or retirees because of its secular trends, increasing revenue, and strong cash flows being returned to shareholders.
