Analog Devices, Inc. engages in the design, manufacture, and marketing of analog, mixed-signal, and digital signal processing integrated circuits used in industrial, communication, computer, and consumer applications. Its products are used in communications applications that include wireless handsets and wireless base stations, as well as products used for high-speed access to the Internet, including central office networking equipment.

ADI is not a dividend achiever and has started paying dividends since last 5 years only. The most recent dividend increase was in May 2008. I am impressed by ADI’s strong balance sheet and free cash flow. My objective here is to analyze if ADI has any potential to be a good dividend growth stock and how does it rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

• Revenue: In general, a flat trend since 2000. The average revenue growth for last 10 years has been approximately 9%. Year 2001 and 2002 shows the significant dip which was the aftermath of the tech bubble. It may be intriguing that while revenue seems flat where is growth coming from? This is because, when we remove discontinued or sold business units, there is revenue growth from the existing business.
• Cash Flows: Overall, stable to increasing trend for free cash flow and operating cash flow. It is good indicator that FCF is almost always greater than income.
• EPS from continuing operation: In general, it has an increasing trend since 2002.
• Dividends per share: Increasing trend since its start in 2003.

ADI: Trend Analysis

ADI: Data Summary

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 2.0. This is a medium risk category as per my 3-point risk scale. The increased payout factor and sluggish EPS growth rate (relative to its historical average) makes it a medium risk to dividends.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

• Dividend growth rate: The average dividend growth of 50% (stdev. 26%) is completely different that average EPS growth rate of 19.4% (stdev. 98%). The dividends growth rate is not supported by EPS growth rate indicating that it is going to slow down.
• Duration of dividend growth: 5 years.
• 4 year rolling dividend growth rate for past ten years: Not enough history.
• Payout factor: In the past 5 years, it has been lower than 50%. This is another indicator that dividend growth is less likely or it does increase it will be high risk.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.93%; and (b) MMA yield is 3.4%. Last 5 years average dividend growth rate has been 50% which is unrealistic. My projected dividend growth rate is 6%. With my projected dividend growth of 6%, the dividend cash flow is 1.08 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $15.00 (i.e. yield 5.33%)

Fair Value Calculation

This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $14.1
• Average high yield price calculated based on past 10 years: $42.5
• Pricing based on past 10 year relative price-to-earnings ratio. $30.5
• Pricing based on price-to-earnings ratio of 12: $19.0
• Graham number: $16.3

The range of fair value is calculated as $18.6 to $24.5. I determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value).

Qualitative Analysis
Analog Devices, Inc., is about 43 year old technology based company. It is built on the foundation of innovation by its founder Ray Stata who is still associated with the company. It has survived all the ups and downs of technology industry. One aspect that I like is its ability to command 50% gross margins on its products.

• ADI’s revenue is pretty diversified in few different product sectors and geographical region. Close to half of its revenue comes from outside of North America. Overall, it has about 10000 products (including derivatives). Its major market sector is industrial electronics and hence is poised to grow with continued industrialization of emerging markets.
• It has a very strong balance sheet with practically no debt and sustained free cash flow. Even in this recessionary market, it is able to command 50%+ gross margin on its products.
• Its key strength is core competency in high performance analog chips. These are the chips that convert real world analog signals into digital signals which are further processed for clarity. Every electronics product in the market today will have some form of data converter. ADI has more than 60% worldwide market share in data converters. Its products have more than 8 years of life cycle.
• One significant concern that I have is; being in lucrative market segment, it is likely that it may face increasing competition. Even Texas Instruments has regrouped to focus of higher performance analog market segment.
• I believe it will remain highly profitable company, but with slower growth in revenue.
• With respect to dividends, I believe ADI has sufficient financial muscle to continue its dividends and sustain mid single digit growth. However, I would be wary of managements’ dividend strategy. It does not have a long history of dividends.

Conclusion
I like ADI’s diversified revenue stream and geographical presence. Overall, it is a US based company that will provide hedge against dollar fluctuation and proxy for foreign developed/emerging markets. It truly has a very strong balance sheet that includes free cash flow and practically zero debt. I also like the fact that company continues to remain focused on its core competency which gives it higher gross margin products. I stop short of starting any position because of (1) my concern whether management will continue its dividend policy; (2) changing competitive landscape with more competitors joining in, which was not the case earlier; and (3) current pricing is higher than my fair value range. I would be willing to take dividend risk provided I get an opportunity to buy at lower end of my fair value range.

Full Disclosure: No position at the time of writing.

This article originally appeared on The DIV-Net on August 13, 2009

This article originally appeared on The DIV-Net on June 11, 2009

Intel Corporation (INTC) designs, manufactures, and sells integrated circuits for computing and communications industries worldwide. It offers microprocessor products used in desktops, workstations, servers, embedded products, communications products, notebooks, netbooks, mobile Internet devices, and consumer electronics. It also offers chipsets with embedded designs for industrial equipments, point-of-sale systems, panel PCs, automotive information/entertainment systems, and medical equipment.

INTC is not a dividend achiever. It has been paying growing dividends for last 5 years. I had shortlisted INTC for more analysis in my list of potential for dividend growth investments and opportunities for technology dividends. Keeping with that, my objective here is to analyze if INTC is a good dividend growth stock and how it will rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 8 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

• Revenue: Consistently slow growing revenue since 2001. The average revenue growth for last 8 years is 3.5% (with 12.4% standard deviation). This indicating negative growth rates.
• Cash Flows: In general, a range bound operating cash flow. The free cash flow is generally close to net income.
• EPS from continuing operation: In general, a range bound EPS from continuing operations.
• Dividends per share: Consistently growing dividends since 2003.

INTC - Trends

INTC - Data Summary

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 2.3. This is a medium risk category as per my 3-point risk scale. The increased payout factor and erratic EPS makes it a medium risk to dividends.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

• Dividend growth rate: The average dividend growth of 34.3% (stdev. 41.57%) is more than average EPS growth rate of 24.0% (stdev. 67.82%). Dividends have grown faster than earnings per share.
• Duration of dividend growth: 5 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10% for past 8 years. More than 10% for last five years.
• Payout factor: In the past 8 years, it has been in the range of 10% to 60%. Very wide range. It is now at 60%.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 3.5%; and (b) MMA yield is 3.4%. Last 8 years average dividend growth rate has been 34%. I do not expect INTC dividend growth rate at 34%. With my projected dividend growth of 3.5%, the dividend cash flow is equal to MMA income.

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $6.2
• Average high yield price calculated based on past 10 years: $23.8
• Pricing based on past 8 year relative price-to-earnings ratio. $23.6
• Pricing based on price-to-earnings ratio of 12: $9.3
• Graham number: $10.4

The range of fair value is calculated as $10.5 to $14.7. This is determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value).

Qualitative Analysis
INTC continues to remain un-challenged leader in the computing microprocessor market segment. Its sole challenger, AMD keeps raring its head every once in a while. However, it has not seen any sustained challenge. On occasions this makes the company complacent and ignoring what the markets wants.

• Like with any other technology company it is operates in a cyclical industry. Current recession seems to have had a significant impact.
• The company seems to have entered into stagnation phase where it already has majority of market share. It banks of expansion of market for growth.
• INTC is continuously searching for new growth areas with not much success so far.
• Lately, it has two initiatives to go into newer market segments viz. the health care products by tying up with GE and the MIDI devices using its low cost ATOM family of products. Time will tell whether these two areas provide any growth to the company.
• The growth in dividends in last five years seems to be the result of historically low payout factor. This dividend growth does not seem to be as a result of the growth in EPS.

Conclusion
I like INTC technological driven supremacy in its product segment. It has been raising dividends for last five years only. This growth seems be due to historically low payout factor instead of growth in EPS. The stock’s current risk-to-dividend rating is 2.3 (medium risk). I will continue to hold my existing INTC stock in my dividend portfolio. However, I will not be adding to my INTC position.

Full Disclosure: Long on INTC.

This article originally appeared on The DIV-Net, March 25, 2009.

Standard and Poor’s “S&P North American Technology Sector Index” (henceforth referred as Tech index) is widely used to benchmark the technology sector in North America. As of February 2008 the Tech index had a weightage of approximately 20% to 23% in overall S&P500 index.

The Tech index represents different sub sectors that include hardware (20 companies), internet (21 companies), multimedia networking (27 companies), semiconductors (43 companies), services (31 companies), and software (40 companies). This is a total to 182 companies in the Tech index. However, similar to any market capitalization based index, Tech index is also top heavy. The cumulative weightage for top 10 companies is approximately 64%, for top 20 companies it is approximately 79%, while top 30 companies it is approximately 86%. The table below shows top 30 companies including the annual per share dividends. There are 17 companies out of top 30 companies that pay quarterly dividends.

Technology Dividends

In general, the notable positive characteristics of tech titans are free cash flow, low level of debt (zero in many cases), higher gross margins, and cash on balance sheet. In this first group, the prominent one are that have paid consistent dividends. These include AT&T (T), International Business Machines (IBM), Verizon (VZ), Automatic Data Processing (ADP), and Paychex (PAYX). These companies have demonstrated sustainability of dividends and growth of dividends over a period of time. Keen observer will note that these companies are from services sector. All type of dividend investors know these companies very well.

In addition, the second group consists of notable tech titans that have paid or started paying small amount of dividends in last few years. These are Qualcomm (QCOM), Intel (INTC), Microsoft (MSFT), Hewlett and Packard (HPQ), Texas Instruments (TI), and Master Card (MA).

Contrarily, there are few other companies that have not had any favorable dividend policy. The argument for no dividends has been that they need cash for continued innovation and growth. In this third group, the prominent ones that have not paid dividends are Cisco (CSCO), Apple (AAPL), Google (GOOG), Oracle (ORCL), EMC Corp (EMC), eBay (EBAY), and Dell (DELL). Keen observer will note that majority are these companies are from hardware sector.

First group: These companies have demonstrated favorable dividend policy. If not all, then for most of the companies, pricing have come down to an attractive level.

Second group: These companies are the ones that have potential to become dividend champions (and may be dividend aristocrats). The most promising ones are Intel (INTC), Qualcomm (QCOM), and Master Card (MA).

• Intel: Its technological-driven market leadership is so high that it just does not have any significant competitor. It still continues its hunger for more product diversification such as netbooks, WIMAX, etc.
• Qualcomm: Its CDMA technology provides a stable royalty based cash flow, its chipset in CDMA and 3G domain is market leaders, attempting to diversify in netbooks with new platforms, and chipset competitors (Freescale, Infineon, TI, et. al.) falling apart. It would be prudent to say QCOM is soon becoming Google of wireless communication.
• Master Card: Its service based business model and world wide reach makes it a potential dividend investment.
• Microsoft: I did not include it because I am wary of its habit of squandering cash in meaningless acquisitions.

Third group: At the time of this writing, Oracle declared its first dividend. In addition, one other company to watch out for start of dividends is Cisco. It’s chief executive has shown some inclination to start paying dividends. Apple and Google have not shown any inclination to pay dividends. Dividend investors will have to wait and watch until companies in this group have shown some consistency and sustainability.

The first group and second group are where dividend opportunities exist for long term dividend investors.

Full Disclosure: At the time of this writing, long on INTC and PAYX.