AVGO - 2 Dividend Growth Names For Your Watchlist

2023-03-10 13:18:14 ET

Summary

• Broadcom Inc. is a semiconductor company that has experienced tremendous growth and provided results to shareholders.
• Raytheon Technologies Corporation is an aerospace and defense name with an attractive split between government and commercial business.
• Both of these names provide attractive dividend growth, and with anticipated earnings growth going forward, it seems this trend can continue.

Written by Nick Ackerman. This article was originally published to members of Cash Builder Opportunities on February 24th, 2023.

Recently Intel Corporation ( INTC ) slashed its dividend by 66%. That prompted me to exit my position with what I considered to be a name in my core portfolio. I don't have any firm methodology or solid rules regarding investing. I feel that the market is fluid and ever-changing. Therefore, I feel that investing only in things that meet certain rigid criteria doesn't always make sense.

That being said, one guideline I generally follow is selling out of a position that cuts that was previously a dividend grower. These names have tended to continue to underperform after the dividend cut, generally due to a deteriorating business and, thus, why a dividend cut was prudent in the first place. In my case, it has proven to be a wise move historically, but it's important to realize that it's a case-by-case situation. The previous case where I considered a position a core name and they cut was AT&T Inc. ( T ).

Selling out of INTC opens up the discussion to one of my other loose guidelines. That is that I want 30 positions that I can consider core positions. Primarily large-cap companies that have offered dividends that trend higher over time fit my definition. Some industries that are quite cyclical aren't always consistent raisers annually but trend higher over time. Caterpillar ( CAT ) is one name that comes to mind. I'm also not solely bound to only C-Corp stocks, as BDCs, MLPs, and REITs are also included. With only being a loose guideline, I'm not in a big hurry to replace it and can be a bit patient here.

On a side note, I actually followed selling my INTC position by selling puts at a lower price. This would potentially see me become long the shares again, but at a lower cost. Additionally, it is within a different account, and at this point, I'd consider it a speculative position.

With this background, there were two names that popped up on my radar. Names I've looked at these in the past, but I thought these would be appropriate for giving a renewed and deeper look at their current situation. That would be Broadcom Inc. ( AVGO ) and Raytheon Technologies Corporation ( RTX ). I believe both of these names are solid bets in the long-term and well worth an investor putting them on their watch list.

Broadcom

Going with AVGO would certainly keep it within the same industry, albeit going with a fabless operation. With a seemingly much better growth trajectory, it would certainly be an upgrade. Fabless simply means in the semiconductor industry that they don't make their own chips; they design them and are then sent to a foundry to be made.

Additionally, the company also has business in the infrastructure software space. So they can provide a bit more diversification, but with the most significant slice of the pie being dedicated to semiconductor solutions.

This can be important because they are quite reliant on Apple Inc. ( AAPL ), which provides around 20% of their revenue. One of my main hesitations about AVGO is this reliance. That hesitation was only further fueled when it was reported that Apple was looking to replace some of its chips by 2025. However, then it wasn't too much longer, and the shares "spiked" following a report that Apple was halting work on its own chips.

Speaking of diversification and their infrastructure software business, they had announced they were looking to acquire VMware, Inc. ( VMW ) for a sum of $61 billion . A sizeable acquisition could push them further into software to help break away from more reliance on Apple further. With any sort of sizeable deal such as this, they are facing scrutiny , and it isn't certain that the deal with eventually be realized.

Despite these very real concerns, the company is still expected to grow its earnings and revenue over the coming years. With only 1 analyst providing an EPS estimate in 2026, we should view it with considerable skepticism, but at least it shows one analyst isn't worried about Apple.

Also worth mentioning is that AVGO is not providing guidance for the year during this uncertain period. Instead, they are taking it on a quarter-by-quarter basis. Given the expectations for a recession, I certainly don't blame them.

In summary, we're guiding consolidated Q1 revenue of $8.9 billion, up 16% year-on-year. While we are fully booked for fiscal 2023, in this environment, we are not providing you guidance for the year.

Growth going forward is important for a dividend growth stock as it can provide a means to continue to reward shareholders through a growing dividend or potential buybacks. With the latest dividend, the forward EPS payout ratio comes to roughly 45%.

They target a roughly 50% free cash flow payout from the preceding year. That meant that as they've experienced sizeable free cash flow growth, the dividend has also risen. The latest dividend yield works out to a fairly attractive 3.15%. When looking at dividend growth names, the actual upfront dividend yield doesn't play any role in my choice.

The latest dividend increase was 12.2%, a slowdown from the ~40% 10-year CAGR, but certainly still impressive. A 40% CAGR is certainly not going to be something that is going to be sustainable over an extended period of time going forward. Eventually, the size starts to become an issue, and growth tends to slow down at a point when companies become so large.

In terms of valuation, the company's shares aren't overly elevated. Wall Street analysts have an average price target of $656. Based on the historical P/E range, AVGO is much closer to the lower end of that range. Therefore, a purchase at today's level seems to indicate there could be some upside from here.

However, with an incredibly volatile and uncertain market, being patient doesn't seem to be a bad idea for now. Of course, that carries its own risks, as any indication that inflation is slowing and the Fed is winning could likely see shares rise significantly and rapidly. Which could push the price of the shares up to a point where we could consider it overvalued. Taking a dollar-cost average approach could be warranted.

Raytheon Technologies

RTX is in the aerospace and defense industry, an area I've not been exposed to since my days of holding The Boeing Company ( BA ). BA is a name I previously cut from my portfolio when they eliminated their dividend. I understand some folks are growth investors, and BA has certainly provided some upside since then. Still, I prefer to get some of my returns via dividends, particularly with individual positions leaning towards dividend growth names.

Somewhat of a small change for the company is that they are taking their four business segments and realigning them into three business units. This is anticipated to take place in the second half of the year. Essentially, this will take the current segments of Raytheon Intelligence & Space and combine them with the Raytheon Missiles & Defense segment.

A company such as RTX will seemingly always have some demand. As geopolitical tensions only seem to flare up continually, we know war isn't going anywhere, unfortunately.

My rationale for leaning towards RTX rather than Lockheed Martin ( LMT ) or Northrop Grumman ( NOC ), as I did look at both, is that RTX provides a bit more diversification between government and commercial. In the last fiscal year , sales to the U.S. Government were by far the largest in terms of net sales, coming in at 45%. In total, 59% of their sales were to governments, leaving 41% to commercial.

This can help balance things out when one side of the equation might not be doing as well as the other. According to Wall Street analysts, they believe that both LMT and NOC will see EPS lower for their fiscal 2023 years. Although only slightly lower for LMT but regardless, they are expecting some growth for RTX.

RTX expects adjusted EPS to hit $4.90 to $5.05, over the $4.78 they earned in 2022. They expect a free cash flow of $4.8 billion. Notably, that's slightly below the $4.9 billion reported in 2022, which had exceeded their expectations. So potentially, they are looking to under-promise and overdeliver once again. At least providing earnings surprises to the upside against analysts' expectations is something they regularly do. Sixteen out of the last sixteen quarters, they beat analysts' EPS expectations.

They've been growing their dividend at a quite attractive pace for a number of years. However, depending on where the information is sourced, it can look like they cut their dividend. This is because the Raytheon Technologies we know today was the product of a merger of United Technologies and Raytheon in 2020. Looking at the investor relations website provides historical information on each of the companies previous to the merger . In that, we can see the impressive track records of each.

With earnings expected to continue to grow, we can expect the dividend to continue to grow as well. In this case, the dividend growth has actually accelerated with the latest dividend bump rather than slowed down. The 10-year CAGR growth comes to 5.30%. The last increase was an impressive 7.84%. The latest dividend yield comes to 2.21% for this company.

If they stick with their historical pattern of raising their dividend in Q2 2023, the next announcement, sometime in April, should see another increase. Now, if it's slower than last year, I wouldn't be too upset as most companies are becoming increasingly conservative for this year.

Where my main pause comes in with shares of RTX is that it seems every investor wants some piece of defense exposure. LMT, NOC, and even RTX are all trading in the upper range of their fair value estimate. RTX would need to fall to around $91 before hitting the mid-range of their fair value, with having to drop closer to the low $80s before being considered a fairly attractive price.

Getting the absolute lows might not mean too much for a longer-term investor, but we can still strive for a halfway reasonable entry price. Alternatively, this is another place where a dollar-cost average approach could once again be a viable path to starting a position and building it up over time.

Conclusion

I believe that Broadcom Inc. and Raytheon Technologies Corporation both provide characteristics of investments that could be considered core-type holdings. Those types of holdings that one should be able to buy and hold for the most part unless something fundamentally changes. That's why these names will see their way on my watch list and potentially into my portfolio. While Broadcom presents a reasonable entry price now, Raytheon Technologies Corporation appears to be trading at an elevated valuation based on its historical fair value estimate.

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