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

The US is home to the largest collection of stock exchanges in the world.

As Charlie Munger has said, “the first rule of fishing is to fish where the fish are.”

Well, in a way, investors with access to US-based stocks are “shooting fish in a barrel”.

But one can do even better by only fishing for the best fish.

I’d argue that’s basically what dividend growth investing comes down to.

That’s because this strategy almost automatically excludes lower-quality investments.

Only stocks that pay reliable, rising dividends qualify for the strategy.

Suffice it to say, only great businesses that can reliably increase their profits, year after year, can commit to that kind of capital return strategy.

The Dividend Champions, Contender, and Challengers list says it all.

This list includes invaluable information on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.

Jason Fieber's Dividend Growth PortfolioYou might think that if there are hundreds of stocks that can qualify for the strategy, these names aren’t all that special.

That is, until you remember that there are thousands of US-listed stocks in total.

I’ve used this strategy to my advantage for the last 10+ years of my life, building up my FIRE Fund in the process.

That’s my real-money stock portfolio.

And it generates enough five-figure passive dividend income for me to live off of.

I’ve actually been living off of dividend income for years.

I quit my job (and its comfortable paycheck) in favor of retiring in my early 30s.

How did I do that?

I spell it out in my Early Retirement Blueprint.

As much as dividend growth investing encourages fishing where the best fish are, valuation at the time of investment remains crucial.

Whereas price tells you what you pay, value tells you what you 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.

Supercharging Charlie Munger’s advice to fish where the fish are by buying undervalued high-quality dividend growth stocks, which is akin to fishing for the best fish, sets you down the path to building substantial wealth and passive income over time.

Of course, this concept would mean that you’re able to discern the difference between price and value.

If this is difficult for you, no need to worry.

Fellow contributor Dave Van Knapp’s Lesson 11: Valuation will help you.

As part of a comprehensive series of “lessons” on dividend growth investing, it lays out how to go about valuing dividend growth stocks in a very simple-to-understand manner.

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 semiconductor company focusing on cellular system solutions that enable wireless connectivity.

Founded in 1962, Skyworks Solutions is now a $16 billion (by market cap) tech titan that employs 11,000 people.

The company’s FY 2021 revenue is broken down geographically as follows: United States, 63%; China, 19%; Taiwan, 8%; South Korea, 5%; Europe, Middle East, and Africa, 4%; and Other Asia-Pacific, 1%.

The investment thesis here is very simple.

Our world is increasingly dependent on smartphones and the wireless connectivity, data consumption, and remote productivity they offer to billions of people.

Not only do you have increasing dependency but also increasing content within these phones.

Smartphones continue to need more complex tech in order to facilitate higher degrees of functionality.

All of that plays right into the hands of Skyworks Solutions.

Skyworks Solutions leverages its IP across its product portfolio to make itself an integral part of the global handset value chain.

Primary company products include power amplifiers, filters, switches, and voltage regulators.

Simply put, it would be nigh impossible to manufacture the world’s most popular smartphones without the type of products that Skyworks Solutions provides.

Moreover, the company is increasing its presence across other applications, such as wireless routers, data centers, and automobiles.

All of this bodes well for the company’s long-term outlook and its ability to grow its revenue, profit, and dividend.

Dividend Growth, Growth Rate, Payout Ratio and Yield

Speaking of the dividend, Skyworks Solutions has already increased its dividend for eight consecutive years.

A nice start, especially considering the five-year dividend growth rate of 14.9%.

Double-digit dividend growth doesn’t seem to be stopping, either; the most recent dividend increase, announced only weeks ago, came in at 10.7%.

With a low payout ratio of only 31.5%, I suspect many more double-digit dividend increases in the years ahead.

What’s great here is that you’re able to pair that high dividend growth rate with the stock’s yield of 2.5%.

It’s not often that you see a yield at this level with a dividend growth rate of this magnitude.

Indeed, it’s unusual even for this stock – this yield is 100 basis points higher than its own five-year average.

I see very balanced dividend metrics all the way around here.

I like dividend growth stocks in what I call the “sweet spot” – a yield of between 2.5% and 3.5%, paired with high-single-digit (or higher) dividend growth.

The yield is on the very low end of that range, but the dividend growth is off the charts.

There’s something to like for just about any dividend growth investor.

Revenue and Earnings Growth

As likable as these dividend metrics are, though, they’re mostly looking at the past.

However, investors are risking present capital for the returns and rewards of the future.

As such, I’ll now put together a forward-looking growth trajectory for the business, which will be instrumental when the time comes to estimate intrinsic value for the stock.

I’ll first show you what the company has done over the last decade in terms of its top-line and bottom-line growth.

And I’ll then unveil a professional prognostication for near-term profit growth.

Blending the proven past with a future forecast in this manner should give us the ability to reasonably judge where the business might be going from here.

Skyworks Solutions moved its revenue from $1.6 billion in FY 2012 to $5.1 billion in FY 2021.

That’s a compound annual growth rate of 13.8%.

I rarely see revenue compound at a double-digit rate over a long period of time.

Tremendous top-line growth here.

Meanwhile, earnings per share grew from $1.05 to $8.97 over this period, which is a CAGR of 26.9%.

Wow.

Bottom-line growth is even more impressive than top-line growth.

These are truly terrific growth rates.

A mixture of pronounced margin expansion and share buybacks helped to drive a lot of excess bottom-line growth.

For perspective on the latter point, the outstanding share count has been reduced by 13% over the last decade.

Looking forward, CFRA is forecasting that Skyworks Solutions will compound its EPS at an annual rate of 22% over the next three years.

So CFRA is expecting the next few years to look a lot like the last 10 years.

I imagine that’ll bring a smile to a shareholder’s face.

CFRA notes that Skyworks Solutions has benefited from 5G uptake, which led to greater RF content in handsets.

However, CFRA is a bit cautious on this story moving forward: “Although mobile has benefited from the shift to 5G by smartphone makers (higher RF content), upside ahead is seen as being more incremental.”

On the other hand, CFRA rightly points out its enthusiasm about something I touched on earlier – Skyworks Solutions has broadened itself out: “We remain optimistic about prospects in SWKS’s broad markets (up 38%), on greater penetration in faster-growing end markets, including automotive, industrial, data center and network infrastructure.”

I see this as a very wise move by Skyworks Solutions.

Its Achilles heel has long been its heavy reliance on handsets, in general, and Apple Inc. (AAPL), in particular.

Indeed, Skyworks Solutions reported that sales to Apple comprised nearly 60% of last fiscal year’s revenue.

That is an extraordinarily high amount of customer concentration.

Skyworks Solutions is parlaying its prior successes with Apple into other lucrative opportunities, which fortifies the entire business.

If the company is able to come anywhere close to CFRA’s EPS growth projection over the coming years, that bodes extremely well for the size of dividend raises.

With a low payout ratio, the dividend could easily continue to grow at a double-digit rate for many more years.

Pairing that kind of dividend growth with the 2.5% starting yield is one of the more compelling combinations of yield and growth that I’ve run across.

Financial Position

Moving over to the balance sheet, Skyworks Solutions has an outstanding financial position.

The long-term debt/equity ratio is 0.4, while the interest coverage ratio is north of 33.

Profitability is extremely robust.

And this profitability has only improved of late.

Over the last five years, the firm has averaged annual net margin of 25.9% and annual return on equity of 24.4%.

Circling back around to the net margin expansion I touched on earlier, annual net margin was routinely under 20% a decade ago.

This is an exceptional business.

I see nothing but excellent fundamentals across the board.

And the company is protected by 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.

I see customer concentration as the biggest risk. Skyworks Solutions is heavily reliant on sales to Apple. Any negative changes to this relationship could be detrimental to the business.

5G adoption has largely already played out, leaving the company with less near-term growth from this opportunity.

The company is taking steps to diversify the business, but these steps add uncertainty and execution risks.

The strong dollar adds near-term currency exchange challenges.

Kinks in the global supply chain could weigh on the business.

There are also geopolitical risks, as China is the company’s second-largest geographic area of revenue.

Lastly, the very business model is a risk. The company must stay ahead of the tech curve in order to not get left behind.

I do see these risks as higher than average, but the stock’s valuation is also well below average.

After seeing its price get cut nearly in half, the stock’s valuation is now as attractive as I’ve ever seen it…

Stock Price Valuation

The P/E ratio is sitting at 12.7.

This is quite a bit lower than the broader market’s earnings multiple.

It’s also measurably lower than its own five-year average of 20.1.

For a company that has compounded its EPS at 26.9% annually for the last decade, a P/E ratio of 12.7 is absurd.

That leaves us with a PEG ratio of about 0.5.

The P/CF ratio of 10.4 is also way off of its own five-year average of 14.3.

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 8%.

This dividend growth rate is as high as I’ll go, but this company deserves the designation.

Keep in mind, this is a company that has grown its EPS at a rate of approximately 27% over the last decade, and it’s expected to do something similar over the next few years.

Its dividend growth rate over the last five years is almost double where I’m at in this model.

Plus, the payout ratio remains low.

Skyworks Solutions could easily power the dividend well beyond this 8% growth rate over the next few years, but growth may very well moderate beyond that point.

I do like to err on the side of caution, but this is actually a pretty conservative number for this business.

The DDM analysis gives me a fair value of $133.92.

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 put together a reasonable valuation model, yet the stock still comes out looking super 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 5-star stock, with a fair value estimate of $180.00.

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 $122.00.

I came out fairly close to where CFRA is at, but we all generally agree that the stock looks cheap. Averaging the three numbers out gives us a final valuation of $145.31, which would indicate the stock is possibly 45% undervalued.

Bottom line: Skyworks Solutions Inc. (SWKS) is a fantastic business with excellent fundamentals across the board. And they’ve taken wise steps to broaden out the business and make it even better. With a market-beating yield, double-digit dividend growth, a low payout ratio, nearly 10 consecutive years of dividend raises, and the potential that shares are 45% undervalued, this could be one of the best combinations of quality and value in the whole market for long-term dividend growth investors.

— Jason Fieber

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.

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.

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Source: Dividends & Income