Undervalued Dividend Growth Stock of the Week: Skyworks Solutions (SWKS)

There’s a technological revolution in front of us.

Mobile, wireless, automation, AI, 5G.

These are all important terms.

But it goes way beyond simple terminology.

These are the investment opportunities of a lifetime.

Technology is necessary for our everyday lives.

And this dependency is increasing. Rapidly.

The companies providing the backbone of 21st century technology are poised to profit handsomely.

And that bodes well for their shareholders.

Fortunately, it’s not difficult to spot these companies.

Furthermore, an investor doesn’t have to rely on the ups and downs of the stock market to produce cash flow from these tech investments.

Many of the world’s biggest and best technology companies pay growing dividends.

I’ve used dividend growth investing to go from broke at 27 years old to financially free at 33.

I lay out how I did that in my Early Retirement Blueprint.

By building my FIRE Fund with intelligent saving and investing choices, I now live off of five-figure dividend income.

Dividend growth investing is an amazing strategy for building wealth and cash flow.

The strategy simply involves buying stock in world-class enterprises that are sharing a portion of their profit with shareholders. 

That profit portion comes in the form of cash dividend payments. And as profit grows, so should (and does) the dividends.

Technology shouldn’t be shunned by dividend growth investors.

Jason Fieber's Dividend Growth PortfolioIn fact, some of the biggest dividend payers in the world are tech companies.

Check out the Dividend Champions, Contenders, and Challengers list for proof of that.

Of course, you want to make sure  you’re buying the highest-quality companies – regardless of the industry.

And you have to pay the right price.

While price is what you pay, it’s value that you get.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and reduced risk.

That’s relative to what the same stock might otherwise offer if it were fairly valued or overvalued.

Price and yield are inversely correlated.

All else equal, a lower price results in a higher yield.

Since total return is the sum of investment income and capital gain, the higher yield leads to greater long-term total return potential.

All of this should reduce risk.

Undervaluation introduces a margin of safety.

That’s a “buffer” that protect the investor against downside in the face of unforeseen changes/challenges that can impair a company’s value.

These dynamics are clearly favorable.

The good news is, they’re not difficult to spot and take advantage of.

Fellow contributor Dave Van Knapp has made that process easier than ever before with Lesson 11: Valuation.

Part of an overarching series of “lessons” on DGI, that specific article provides a thoughtful and actionable template for valuing dividend growth stocks.

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 a global semiconductor company that produces components to enable wireless connectivity across communication devices.

Founded in 1962, it’s grown to become one of the premier providers of RF components used in smartphones.

With a market cap of $12 billion, this is one of the very companies providing the backbone for 21st century technology.

Smartphones have become like appendages for people. Access to mobile communications and data may as well be a utility at this point.

The point is, people can’t (or feel like they can’t) live without their smartphones.

There are a handful of companies that manufacture the bulk of the technology that goes into smartphones.

Skyworks Solutions is one of those companies.

If that’s not enough, they have tremendous tailwinds on their side.

First, and most important, there’s the 5G revolution.

This will make access to data more ubiquitous than ever before, all while creating a ramp for extra smartphone demand as people seek out the newest tech.

Not only that, but 5G also means more and more expensive “content” per phone.

Phones have become more advanced, and they require more technology than ever before.

Putting this into real dollars, the company estimates it will earn almost 40% more per 5G phone than it does with 4G phones.

Then there’s the fact that, per company estimates, there are over two billion “unconnected” people across the world.

That’s a massive growth runway.

These people will no doubt become connected over time as access to wireless improves globally all while smartphone demand simultaneously increases.

All of this adds up to a very intriguing long-term picture, which translates well to the dividend.

As it sits, the company has increased its dividend for five consecutive years.

Sure, that’s not a lengthy track record.

But what they lack in length, they make up for in growth.

The three-year dividend growth rate is 21.5%.

And the most recent increase was almost 19%, so there’s not much of a slowdown here.

With a payout ratio of just 25.5%, the dividend is well-covered and positioned to continue growing at a very high rate.

All of this comes on top of a 2.09% yield.

That yield is almost 80 basis points higher than the stock’s own five-year average yield.

This speaks on what I noted earlier about valuation and yield.

However, the first year or so of this time frame reaches back to when the company initially started paying a dividend.

As such, it’s difficult to make much of this comparison.

Still, the dividend metrics are strong.

A 2%+ yield and ~20% dividend growth sets investors up very nicely.

Assuming a static valuation, total return should equal the sum of yield and dividend growth.

Unless there’s some kind of valuation compression from here, which I find unlikely outside of a recession, investors could do quite well over the long run with this business.

Now, I don’t anticipate them to indefinitely grow the dividend 20%+ annually.

But I don’t think it’s unreasonable to expect low-double-digit dividend raises for the foreseeable future.

I’ll show you why that expectation seems reasonable.

Building out that expectation will require us to first look at what the company has done over the long haul in terms of top-line and bottom-line growth.

Then we’ll compare that to a near-term professional expectation for profit growth.

Since dividend growth should roughly mirror profit growth over the long run, this should allow us to create a dividend growth trajectory.

The company increased revenue from $803 million in FY 2009 to $3.868 billion in FY 2018. That’s a compound annual growth rate of 19.09%.

Obviously, that’s stunning.

I usually look for mid-single-digit revenue growth. Skyworks Solutions blew that away.

To be fair, though, this period started at the trough of the Great Recession.

More recent growth has been slightly less impressive but still swift.

If this doesn’t catch your attention, check out the bottom line.

Earnings per share advanced from $0.56 to $7.22 over this stretch, which is a CAGR of 32.85%.

(I used adjusted EPS for FY 2018 because there was a large tax hit to Q1 2018 GAAP EPS. This was related to US tax reform. That tax hit doesn’t materially impact the company’s true earnings power.)

Gaudy numbers here. The company has taken full advantage of the smartphone revolution over the last decade.

Notably, the excess bottom-line growth was driven by a substantial expansion in net margin.

For perspective, net margin in FY was under 12%. It’s coming in at almost 30% for the TTM numbers.

Looking out over the next three years, CFRA is predicting that Skyworks Solutions will compound its EPS at an annual rate of 5%.

Now, a 5% growth rate is well below what this company has done over the last decade.

Furthermore, this is a material drop compared to what CFRA’s forecast was just a few months ago.

What’s going on?

The downward shift has been prompted by trade tensions between the US and China, as well as the US ban on the Chinese company Huawei.

The latter is particularly bruising. Huawei made up approximately 12% of recent sales for Skyworks Solutions.

That demand could very well shift elsewhere. But it adds a lot of uncertainty and complexity.

Regarding the trade tensions, this is further and unwelcome complexity and uncertainty.

The company has a lot of exposure to China.

Foxconn, which is more or less a proxy for Apple Inc. (AAPL), makes up approximately 40% of Skyworks Solutions’ sales.

As such, these trade tensions have far-reaching consequences and could reverberate across the company’s operations.

It’s very difficult to say what’s going to happen over the near term. But the long-term picture remains intact.

If we take this 5% forecast at face value, that still leaves room for low-double-digit dividend raises. This is due to the fact that the payout ratio is still so low.

Actually, the company could face EPS compression over the near term and still grow the dividend aggressively based on the otherwise incredible fundamentals.

For further proof of that, I present the fortress balance sheet.

It’s truly beautiful.

The company has no long-term debt.

And they have over $1 billion in total cash.

That’s plenty of cash for a company with a market cap of ~$12.5 billion.

Moreover, there’s the profitability, which I hinted on earlier.

Over the last five years, the company has averaged annual net margin of 25.23% and annual return on equity of 25.31%.

Again, gaudy numbers.

Yes, the short term is uncertain.

Yes, there are risks.

Namely, there’s the ongoing issues between the US and China. There are probably few companies more exposed to that than Skyworks Solutions.

Competition, litigation, and regulation are omnipresent risks for every business.

Another risk is the customer concentration. As noted earlier, Skyworks Solutions heavily relies on Apple. Any kind of supplier change there would be devastating.

Overall, however, this company is in a great position to cushion the short-term blows and ride out the storm.

And after a ~27% drop in the stock’s price over the last year, the valuation seems to be more than pricing in these short-term problems…

The stock is trading hands for a P/E ratio of 12.15.

That’s almost half of the stock’s five-year average P/E ratio of 21.2.

I get it. There’s uncertainty. But that’s a pretty steep valuation compression.

Digging into cash flow, the P/CF ratio of 10.8 is way off of its three-year average of 13.4.

And the yield, as shown earlier, is significantly higher than its recent historical average.

So the stock does look cheap. 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 8%.

Admittedly, that DGR is on the high end of what I ordinarily allow for in the model.

But I think this company could easily grow its dividend at this rate – and much higher.

The near term may be bumpy.

However, the payout ratio is extremely low, future tech is coming, and the balance sheet is stocked with cash.

The DDM analysis gives me a fair value of $82.08.

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.

My valuation model was arguably conservative, yet the stock still looks very 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 4-star stock, with a fair value estimate of $105.00.

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 5-star “STRONG BUY”, with a 12-month target price of $85.00.

I came out a bit low. Averaging the three numbers out gives us a final valuation of $90.69. That would indicate the stock is possibly 25% undervalued.

Bottom line: Skyworks Solutions Inc. (SWKS) is a high-quality company with excellent fundamentals. The ongoing technology revolution, particularly as it relates to 5G, plays right into this company’s hand and provides a huge tailwind. Double-digit dividend growth, a very low payout ratio, a fortress balance sheet, and the potential that shares are 25% undervalued all add up to a compelling long-term investment opportunity for dividend growth investors.

-Jason Fieber

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Note from DTA: 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 71. 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 a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.