There are so many investing strategies out there.
Some focus on turnarounds, others might focus on deep value net-nets.
On and on it goes.
Now, I’m not sure it’s fair to call any strategy the “best”, because each investor has to invest in a way that best fits their personalities and goals.
But it’s hard to argue against dividend growth investing being a very well-suited strategy for most.
This is a long-term investment strategy that involves buying and holding shares in very high-quality businesses that reward shareholders with steadily rising cash dividends.
Those rising cash dividends are typically funded by rising profits.
And since it’s really difficult for a terrible business to consistently generate more and more profit, this strategy tends to almost automatically funnel an investor right into great businesses.
You can see many examples of what I mean by pulling up the Dividend Champions, Contenders, and Challengers list.
This list has compiled data on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
Because this strategy can limit you to truly great businesses, you can get truly great investment results over time.
I’ve been using this strategy for nearly 15 years.
It’s helped me to build serious wealth, passive income, and freedom in my life.
It guided me as I’ve gone about building the FIRE Fund.
That’s my real-money portfolio, and it throws off enough five-figure passive dividend income for me to live off of.
Circling back around to that freedom point I just touched on, I was actually able to start living off of dividends when I quit my job and retired in my early 30s.
If you’re interested in reading more about that, make sure to check out my Early Retirement Blueprint.
Before I go further, it’s important to point out that this strategy involves more than just investing in great businesses.
Investing at great valuations is also a key component.
That’s because price only represents what you pay, but it’s value that you actually get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.
It’s protection against the possible downside.
Whether or not the dividend growth investing strategy is the “best” is up to you, but there’s no doubt that routinely buying undervalued high-quality dividend growth stocks can lead to awe-inspiring amounts of wealth, passive income, and freedom over time.
Now, the preceding passage assumes that an investor already has a basic understanding of valuation.
If not, no worries.
Fellow contributor Dave Van Knapp’s Lesson 11: Valuation succinctly explains the ins and outs of valuation in simple-to-understand terms so that you can feel more confident in going out and valuing the various dividend growth stocks you’ll run across.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Skyworks Solutions Inc. (SWKS)
Skyworks Solutions Inc. (SWKS) is an analog and mixed-signal semiconductor company focusing on cellular system solutions that enable wireless connectivity.
Founded in 1962, Skyworks Solutions is now a $15 billion (by market cap) tech player that employs just under 10,000 people.
Approximately two-thirds of the company’s revenue comes from the US, whereas the other one-third is derived from international markets (primarily China, Taiwan, and South Korea).
Skyworks Solutions has a global footprint that is comprised of 18 design centers, 15 sales offices, and six manufacturing sites.
Essentially, this company produces a range of integral components that are used in various electronic devices.
Its extensive product portfolio includes (but is not limited to): amplifiers, attenuators, diodes, filters, mixers, modulators, switches, and voltage regulators.
These products are provided to more than 6,000 different customers across the world.
However, as diversified as Skyworks Solutions is (in terms of both products and customers), the majority of the company’s revenue is derived from wireless connectivity solutions (such as RF) – largely for mobile devices.
Skyworks Solutions has fashioned itself into an RF leader.
That’s a great spot to be in, as growing complexity of smartphones leads to more advanced content per device.
So the company can benefit from both volume and pricing.
Of course, Skyworks Solutions has hitched itself to the smartphone wagon, and the company’s fate is now largely tied to that market.
But that’s not a bad thing at all.
There’s almost certainly no future in which the world is using less of this tech.
To the contrary, the world is demanding more and more devices that are interconnected (i.e., IoT) through high-speed networks (such as 5G).
And then you have the rise of AI.
This translates into a need for the lowest possible latency for data, which requires more advanced RF content.
And that plays right into the hands of Skyworks Solutions.
It’s more devices with more advanced content per device.
That’s a powerful two-pronged tailwind for Skyworks Solutions over the coming years.
And that’s why the company is positioned so well to continue growing its revenue, profit, and dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Skyworks Solutions has increased its dividend for 11 consecutive years.
A somewhat short track record, but Skyworks Solutions has gotten off to a nice start with its five-year dividend growth rate of 13.2%.
Gotta love seeing low-teens dividend growth like this, although there has been a noticeable deceleration in dividend growth over the last year or so.
As that growth has slowed, the stock’s yield has rerated much higher in response.
The yield is now sitting at 2.9%.
That is actually very high for this particular stock.
To put that in perspective, this market-beating yield is 120 basis points higher than its own five-year average, giving some early indication of possible undervaluation.
For investors who lean more toward current income and “cash in hand today”, the dynamics for this stock have become more favorable than where they were only a few years ago.
And with a payout ratio of 57.9%, the dividend is healthy and easily covered.
This combination of yield, growth, and safety is very nice.
Revenue and Earnings Growth
As nice as all of it may be, though, some of these dividend metrics are based on what’s already occurred in the past.
However, investors must always have the future top of mind, as today’s capital gets risked for the rewards of tomorrow.
That’s why I’ll now build out a forward-looking growth trajectory for the business, which will be of use when the time comes later to estimate fair value.
I’ll first show you what the business has done over the last decade in terms of its top-line and bottom-line growth.
And I’ll then reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast in this manner should give us what we need to approximate where the business could be going from here.
Skyworks Solutions moved its revenue from $2.3 billion in FY 2014 to $4.8 billion in FY 2023.
That’s a compound annual growth rate of 8.5%.
I usually look for at least mid-single-digit top-line growth from a fairly mature business like this, and Skyworks Solutions is more than getting it done.
Meanwhile, earnings per share grew from $2.38 to $6.13 over this period, which is a CAGR of 11.1%.
Great.
We can see how well dividend growth and EPS growth line up, showing sustainable moves and deft control by management.
Excess bottom-line growth has been fueled by consistent buybacks, and the outstanding share count has been reduced by 17% over the last decade.
Looking forward, CFRA believes that Skyworks Solutions will compound its EPS at an annual rate of 5% over the next three years.
This jibes with a recent slowdown across Skyworks Solutions, stemming from inventory issues and a broader normalization of smartphones after explosive pandemic-related growth.
On one hand, CFRA notes improving inventory levels, a big upcoming smartphone replacement cycle (driven by new AI capabilities), higher levels of RF complexity all boding well for Skyworks Solutions.
In addition, there’s the broadening out of the business.
CFRA highlights this: “Despite uncertainty within its broad markets, we like secular prospects of greater penetration across the automotive, infrastructure, and industrial markets, as well as the shift to WiFi 7.”
However, customer concentration, rising competitive pressures, and the 5G rollout already being behind the business are all cited by CFRA as reasons to be cautious.
I think CFRA is balancing the risks and rewards pretty well here, and I don’t take issue with the caution and near-term 5% growth rate.
Again, though, that’s assuming this is a near-term theme.
If this kind of mid-single-digit growth were to persist for many years to come, that would be a big disappointment for shareholders.
But I don’t see that happening.
The broadening out via penetration across new verticals is, as CFRA rightly noted, a secular growth opportunity.
And that’s before even accounting for the possibility of a very large upgrade cycle across smartphones, due to aged stock and new AI themes driving demand.
Plus, there’s the content story.
It’s hard for Skyworks Solutions to do poorly.
The business simply has too many levers to pull.
That said, expecting more 13%+ dividend growth is probably too much.
But even just mid-single-digit bottom-line growth over the next few years would still be enough to drive similar dividend growth, and better business growth ahead (because of what I just laid out) could easily power high-single-digit (or better) dividend growth over the medium term and beyond.
And those buying in now get to lock in a yield near 3%.
It’s a compelling setup.
Financial Position
Moving over to the balance sheet, Skyworks Solutions has a stellar financial position.
The long-term debt/equity ratio is 0.2, while the interest coverage ratio is north of 23.
As great as these metrics are, they don’t do full justice to the balance sheet strength.
After factoring in cash, the company ended FY 2023 with about $260 million in long-term debt – an immaterial number for a company with a market cap of over $15 billion.
Profitability is very robust.
Return on equity has averaged 21.9% over the last five years, while net margin has averaged 24%.
Impressive.
Skyworks Solutions is generating high returns on capital, and we have world-class margins here.
Lots to like about this high-quality business.
And the company does benefit from durable competitive advantages that include economies of scale, IP, R&D, and technological know-how.
Of course, there are risks to consider.
Competition, regulation, and litigation are omnipresent risks in every industry.
Customer concentration might just be the most obvious risk, with the company’s heavy reliance on Apple not giving it the ability to fully control its own destiny.
The 5G rollout and customer adoption phase has already occurred, eliminating what was a major growth vector.
Diversification and broadening of the business is slowly playing out, but execution risk and uncertainty are present.
The global footprint exposes the company to currency exchange rates and geopolitics, especially in regard to China.
The very business model is a risk unto itself, and the company must stay ahead of the tech curve in order to not get left behind.
There are some risks to consider and appreciate here, which is also true for any equity investment.
However, with the stock down 20% from all-time highs, I think the valuation is something that also deserves to be appreciated right now…
Valuation
The stock’s P/E ratio is 19.9.
Super low?
Not really.
But that’s largely because earnings have come down from elevated levels, and we may just now be on the cusp of the upward swing (which would send earnings higher and this ratio lower, assuming no change to the stock price).
If we move beyond earnings, we see a sales multiple of 3.6 that is well off of its own five-year average of 4.3.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 7.5%.
That growth rate is on the higher end of an allowable range, but it’s not as high as I can go.
Look, Skyworks Solutions has produced double-digit EPS growth over the last decade, and dividend growth has generally been well above this 7.5% level.
Even with the near-term forecast calling for mid-single-digit EPS growth, the dividend could still grow at a high-single-digit rate (by virtue of the payout ratio being where it’s at).
And if the business gets back to its usual ways after this slowdown, a 7.5% expectation would be downright conservative.
Balancing things out, I actually see more upside risk than downside risk to the number over the long run, but I would acknowledge the next year or two will probably require some patience.
The DDM analysis gives me a fair value of $120.40.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
I don’t think my model was overly aggressive, yet the stock still comes out looking decently cheap.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates SWKS as a 3-star stock, with a fair value estimate of $115.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates SWKS as a 3-star “HOLD”, with a 12-month target price of $110.00.
A fairly tight range here, although I came out slightly high. Averaging the three numbers out gives us a final valuation of $115.13, which would indicate the stock is possibly 16% undervalued.
Bottom line: Skyworks Solutions Inc. (SWKS) is a high-quality technology firm that has an incredibly deep product portfolio. The company is busy broadening out even more and gaining new growth vectors. High returns on capital and a stellar balance sheet are hallmarks of its quality. With a market-beating yield, double-digit dividend growth, a balanced payout ratio, more than 10 consecutive years of dividend increases, and the potential that shares are 16% undervalued, this is one of the cheapest and highest-yield opportunities in all of tech for long-term dividend growth investors.
-Jason Fieber
Note from D&I: How safe is SWKS’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 68. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, SWKS’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Disclosure: I’m long SWKS.