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Time to Buy This Dividend Stock With Strong Upside Potential

Usually, one wouldn't associate rapid stock price growth with a dividend-paying company. That's because a part of the earnings generated by a dividend-paying company is returned to shareholders instead of being reinvested in growth opportunities. This typically leads to slow earnings growth and limits the potential for stock price upside.

As such, dividend stocks are usually considered to be mature and stable, while growth stocks are all about reinvesting their money back into the company for faster earnings growth. But Applied Materials (NASDAQ: AMAT) has bucked the conventions of traditional dividend stocks by delivering solid gains this year.

AMAT data by YCharts.

The good news is Applied Materials stock can deliver more upside in 2020. Here's why.

Applied Materials' secular growth opportunity

Applied Materials' dividend yield of 1.44% might not seem very attractive at first considering the technology sector's average yield of 3.20%. However, the lower dividend yield can be attributed to the stock's terrific rise in 2019.

Image source: Getty Images.

Now, Applied Materials didn't do very well in its fiscal 2019 that ended in October. Its revenue and net income fell 13% and 11%, respectively, due to weak semiconductor demand, but 2020 is going to be a much better year for the company. Applied Materials forecast earnings between $0.87 per share and $0.95 per share this quarter on revenue of $4.1 billion.

The company had generated $0.81 per share in earnings on $3.75 billion in revenue in the prior-year period. Meanwhile, Wall Street was originally expecting earnings per share of $0.74 on $3.71 billion in revenue. But Applied Materials' guidance blew past those estimates thanks to the arrival of 5G wireless networks.

Applied Materials anticipates a nice bump in demand for its chip-making equipment in the current fiscal year as the rollout of 5G networks gains momentum. Semiconductor companies will need to upgrade their equipment to churn out advanced chips that can handle the boom in traffic in data centers in the 5G era.

Allied Market Research estimates that the market for 5G chips will hit $2.1 billion next year before reaching nearly $23 billion in 2026. This opens up a secular growth opportunity for Applied Materials, as it is in the business of supplying fabrication equipment to the manufacturers that will be making those chips. This is why the company anticipates a turnaround in its foundry and logic business, which supplies 58% of its total revenue.

However, this isn't the only catalyst that Applied Materials is banking on for next year. The company also anticipates a recovery in the memory business in 2020. CEO Gary Dickerson said on the latest earnings conference call:

In terms of our near-term outlook, while I don't want to speculate about the exact shape or timing of the market recovery, I can characterize what we currently see with three observations. First, strong investment by foundry logic customers driven by demand in key geographies, and acceleration of the 5G road map and commitment to advance the leading edge. Second, early signs of a recovery in NAND investments. And third, the positive progression of the ongoing inventory correction in DRAM.

The memory industry has been under pressure this year due to an oversupply. But global DRAM demand has started gaining some momentum lately. Next year could be a good one for memory demand as shipments of 5G-enabled smartphones improve and data center demand also picks up the pace after this year's inventory correction.

The semiconductor market is expected to expand 5.9% in 2020 after this year's 12.8% decline, according to IHS Markit estimates. So Applied Materials seems poised to enjoy strong growth in the ongoing fiscal year. Analyst estimates compiled by Yahoo! Finance predict a 12.5% rise in the company's revenue along with strong earnings growth, paving the way for a potential dividend increase next year.

Potential dividend hike in the cards

Applied Materials is known to be generous in hiking the dividend payout when its business is doing well. In February 2018, management doubled the quarterly dividend because it follows a policy of returning nearly 90% of free cash flow to investors through share buybacks and dividends -- and has for nearly two decades.

So it wasn't surprising to see the company raise its quarterly dividend by "just" 5% earlier this year thanks to a declining cash flow profile in 2018.

AMAT Free Cash Flow (TTM) data by YCharts.

Now that its forecast indicates that Applied Materials is all set to grow again, there's a good chance the chipmaker will raise its dividend substantially next year. So if you're looking for a dividend stock that's capable of delivering price gains as well, Applied Materials looks like a good bet.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool recommends Applied Materials. The Motley Fool has a disclosure policy.


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