The market’s highest-yielding stocks are not always the best of investments. Their yields might simply be high due to their stocks crashing, and they could be spending over 100% of their earnings and free cash flow (FCF) on their dividends — which shows a dividend cut might likely happen.
Instead of going for high yields, investors should instead focus on well-managed companies that can afford to double their dividends due to good earnings and growing FCF. These firms might give lower yields now, but their stocks will possibly outperform other high-yielding stocks over the long term. These two stocks fit the bill: Nvidia and ASML.
Nvidia began paying dividends back in 2012, but the chipmaker has not impressed investors looking for income with its tiny yield of only 0.08% and inconsistent hikes. Nvidia used only 7% of its FCF on these payments over the previous 12 months, so it’s clearly more focused on expanding its business than giving huge dividends.
This makes sense, since Nvidia must maintain its lead against its rival AMD in the GPU market while creating new high-end GPUs for both driverless cars and data centers. It has been inorganically pushing forward with its takeover of Mellanox and its planned acquisition of Arm Holdings.
However, its $40 billion Arm purchase, the world’s leading mobile chip designer, has hit a wall of opposition from some antitrust regulators. If their takeover fails, Nvidia might repurchase shares or increase its dividend — like Qualcomm did after its failed purchase of NXP — to appease its investors.
Analysts believe Nvidia’s earnings and revenue to rise 58% and 49%, respectively, this year, as it ships more data center and gaming chips. The stock is remaining shockingly cheap at 12 times forward earnings, and a large dividend boost might make it even more attractive.
The Dutch semiconductor equipment maker ASML began paying dividends in 2008 and has increased its payout annually over the previous five years. It currently gives a forward yield of 0.4%, but it spent only 18% of its FCF on these dividends over the previous year.
ASML’s dividends are low because of two reasons. First, it prefers buybacks instead of dividends, which used around $5.1 billion and $1.4 billion of its FCF, respectively, over the previous 12 months. Second, ASML’s stock quadrupled over the previous three years and lowered its yield.
ASML dominates the sector for high-end lithography machines, which Samsung, TSMC, and Intel all need to manufacture their latest and greatest chips. The global chip shortage — and the escalating competition between the world’s top chip producers — is fueling a growing demand for ASML’s products. All it takes is one dividend doubling to make this stock a true gem for both income and growth.
Author: Steven Sinclaire