Each month, we issue The Mike’s Buy List for our DSR members. They get our best ideas for both U.S. and Canadian dividend stocks. The first Friday of each month, they receive our top 10 growth and top 10 retirement (yield over 4%+) investment ideas.
We are still following the virus and its impact on the economy. Considering what happened on the market over the months, I decided to share some of our picks with you. Last time, we covered two growth stocks. Now, let’s look at some two good options for income seeking investors.
What’s the story?
Broadcom published its latest earnings on June 4th. AVGO saw a modest impact from the covid-19 on its business and still managed to post a good quarter. Revenues by segment were Semiconductor solutions, $4.03B (down 2%) and Infrastructure software, $1.72B (up 21%). Cash flow from operations rose to $3.21B from $2.67B, and free cash flow rose to $3.07B from $2.54B. For its Q3, they are guiding for revenue of $5.6B-$5.9B (vs. the consensus for $5.8B), and EBITDA of $3.22B plus or minus $75M which approximates 56% of revenue at the midpoint. “Our third quarter guidance for semiconductors reflects a surge in demand from the cloud, telecom and enterprise customers, offset by supply chain constraints and an expected substantial reset in wireless,” CEO Hock Tan says.
In late June Nokia announced its partnership with AVGO to develop chips for its 5G equipment. We can see a clear hype around the 5G technology and chip makers involved in this sector. AVGO is gaining traction in these markets so it may be time to purchase some shares of this growing company.
Broadcom–the combined entity of Broadcom and Avago–boasts a highly diverse product portfolio across an array of end markets. Avago focused primarily on radio frequency filters and amplifiers used in high-end smartphones, such as the Apple iPhone and Samsung Galaxy devices. This is in addition to an assortment of solutions for wired infrastructure, enterprise storage, and industrial end markets. Legacy Broadcom targeted networking semiconductors, such as switch and physical layer chips, broadband products (such as television set-top box processors), and connectivity chips that handle standards such as Wi-Fi and Bluetooth. The company has acquired Brocade, CA Technologies, and Symantec’s enterprise security business to bolster its offerings in infrastructure software and security.
Broadcom is in a bowl of growth. It manufactures one of the best RF filter, used by all high-end smartphones to improve connectivity. Companies like Apple would not risk their connectivity, right? AVGO’s large size brings economy of scale and enables it to build millions of filters. Its growth-by-acquisition strategy has also turned it into an expert in integrating companies. In a decade, AVGO went from $2B to nearly $22B+ in sales. Broadcom’s expertise and technology will be required across multiple fields such as data center, internet of things, artificial intelligence and cloud equipment.
As AVGO becomes larger, its debt grows accordingly. Losing a major partner, living an economic recession or losing market share could badly hurt. As we enter a recession, AVGO’s clients may want to renegotiate. Broadcom is vulnerable during negotiation with companies like Apple and Samsung. We saw the kind of damage Apple could inflict (Qualcomm anyone?) in the event of a disagreement. Finally, there is always a risk when a business is growing through acquisition. Their latest move (CA) didn’t seem to please the market. With such market volatility, the appetite for debt will reduce and AVGO will face challenges keeping-up with its growth by acquisition strategy.
Dividend Growth Perspective
Broadcom isn’t a classic dividend payer. It needs lots of cash to finance its fast growth and its R&D to keep its edge. Still, the company successfully increased its dividend yearly since 2010. The payout ratio seems quite hectic and out of norm (over 100% many times). This is caused by multiple charges related to its acquisitions and other events. The cash payout ratio is under control. You can expect future increases.
BANK OF MONTREAL (BMO.TO / BMO)
What’s the story?
Canada’s economic resiliency could be proven once more during this pandemic. Quebec has reopened faster than expected, and the number of new cases continues to slow. In Western Canada, they didn’t even see a surge to date. This could be beneficial for BMO and the other Canadian banks.
There are currently no discussions around the Canadian banks’ dividend payments, even after Laurentian Bank cut its distribution last month. Keep in mind Laurentian Bank was already having problems prior to the pandemic, so their dividend cut was likely going to happen regardless of the coronavirus effects on the economy.
Bank of Montreal is a diversified financial services provider based in North America. BMO conducts its business through three operating groups: Personal and Commercial Banking (P&C), Wealth Management and BMO Capital Markets. The bank’s operations are primarily in Canada, with a material portion also within the U.S. It has a strong presence in wealth management through Harris Bank.
BMO decided to take the stock market path to ensure its growth. It was the first Canadian bank with its own ETF on the market. Competition is fierce but being among the first Canadian issuers surely helped to build momentum in a growing market. Over the years, BMO concentrated on developing its expertise in capital markets, wealth management, and the U.S. market. BMO also made innovative moves such as the introduction of its own ETFs and a robo-advisor. Growth will happen in these markets for banks in the upcoming years. BMO is well-positioned to surf this tailwind. When you can grab this bank with a 5.5% yield, you make a good deal.
Relying on capital markets and wealth management as main growth vectors mean BMO can hit a speed bump. While their fact sheet shows an 8% CAGR over the past 15 years, BMO isn’t that generous anymore. After a pause of 3 years in its dividend growth policy, BMO started to grow its dividend again but lags its peers in that field. We don’t see any dividend increases in 2020 for Canadian banks. They must all deal with higher provisions for credit losses. While they are well capitalized, this also means banks will be less generous. As interest rates would be stable at best in 2020, the interest rate margin spread will tighten limiting the bank’s ability to generate higher profit.
Dividend Growth Perspective
BMO hasn’t been the most generous bank in terms of dividend growth lately. Maybe it’s cautious management as it also shows one of the lowest payout ratios and a healthy yield. In general, Canadian banks should appear on your radar each time they reach a 4% yield. We believe BMO’s dividend is safe for now (to be reviewed each quarter), but don’t expect any increase for the rest of 2020.
Fundamental Elements to Manage you Portfolio
It is one thing to build a retirement portfolio. It is another to manage and make sure it will generate the income you need once retired. To succeed, you must follow a simple solution. The clearer and more detailed your methodology is, the easier it is to stick to it and avoid mistakes. Recently, I shared with you three fundamental elements you should always consider when managing your portfolio.