Broadcom (NASDAQ:AVGO) is likely best known for the computer chips it develops. Now, a move into the software business has made it a more diversified tech stock —  and helped it become one of the more intriguing dividend stocks, too. Let’s take a closer look to find out why. 

The Broadcom dividend

Broadcom now pays an annual dividend of $14.40 per share,  a yield of around 3.1% at current prices. That’s nearly double the current S&P 500 dividend yield of approximately 1.6%.

Investors can also remain confident in this dividend. In fiscal 2020, the dividend cost Broadcom just over $5.5 billion, meaning the payout claims about 47% of the company’s free cash flow of $11.6 billion. This leaves the company well-positioned to cover this obligation.

Tweezers lift a chip out of a smartphone circuit board.

Image source: Getty Images

It has also maintained consistent payout hikes. The dividend has risen at least once per year since the company introduced it in 2010. The payout has increased so much that stockholders who bought in November 2009 and held their stock earn close to their original purchase price in dividends every year.

How Broadcom’s business works

Broadcom has supported this payout growth by becoming one of the world’s largest chipmakers. Originally Avago (hence the stock symbol), it adopted the Broadcom name after acquiring a company of that name in 2016.

Broadcom produces chips for multiple applications: devices for networking, storage, and wireless communication, along with data centers.

It credits its competitive advantage to research and development (R&D), focusing on new, proprietary products and emphasizing efficient processes. Broadcom spent almost $5 billion on R&D, nearly 21% of its total net revenue, in fiscal 2020. In comparison, fellow Intel (NASDAQ: INTC) spent just under 18%.

Broadcom also emphasizes customer relationships, employing engineers near its clients to enhance customer support. Among its most prominent clients is Apple. Broadcom signed a contract to provide Apple specified RF modules and components, a contract that will remain in force for the next 2.5 years.

Apple made up about 15% of Broadcom’s revenue in 2020, down from 20% in 2019. Management has acknowledged that losing Apple could have a “material adverse effect” on Broadcom’s overall health. However, Apple just reported record revenue in every product category, and that could bode well for Broadcom’s future. Additionally, the 5G upgrade cycle is in its beginning stages, which might reinforce Apple’s dependence on Broadcom.

A shifting product mix powers profits

Revenue at Broadcom’s semiconductor solutions division dropped 1% from year-ago levels. According to the company, delays in an unidentified client’s ramp to a new mobile handset caused this drop.

However, Broadcom now derives almost 28% of its revenue from software. In recent years, it bought out CA Technologies and Symantec’s enterprise software unit. CA Technologies specializes in areas such as automation, cloud solutions, and data management, while Symantec has always focused on cybersecurity. These purchases have driven Broadcom’s growth in recent quarters: Subscriptions now make up 27% of Broadcom’s revenue, up from 20% in 2019.

Also, the company reported gross margins for fiscal 2020 of 57% compared with 55% in fiscal 2019. Broadcom did not break down how much each division contributed to gross margins. Nonetheless, over the last two years, gross margins have improved amid falling product sales and rising subscription revenue. 

This success in software helped overall revenue to increase by 6% in fiscal 2020. Still, despite rising gross margins, GAAP net income per diluted share fell by about 1% from fiscal 2019 to just over $2.66 billion, or $6.33 per share. Rising R&D and amortization costs and increased selling, general, and administrative expense weighed on operating margins.

Nonetheless, the company projects revenue for the upcoming quarter of about $6.6 billion. If that estimate holds, it will result in an approximate 12% increase from year-ago levels.

A strong business — but at a fair price?

The company’s relative bottom-line stagnation has done little to diminish investors’ enthusiasm for the stock. Broadcom shares rose 53% over the last 12 months, well above the S&P 500’s increase of about 17% over the same period.

AVGO Chart

AVGO data by YCharts

This growth means Broadcom’s dividend income stream will not come cheap. The company’s P/E ratio now approaches 75. This is more than double Qualcomm‘s P/E ratio of approximately 35, and even exceeds AMD‘s earnings multiple of just under 45.

Nonetheless, despite the cost of the stock, Broadcom has developed the technology and customer bases that should help it grow its dividend over time. Its research and customer base place Broadcom where it needs to be to sustain sales growth. Also, a strong software segment should help to boost overall growth even if its semiconductor solutions division continues to stagnate. In the end, a generous dividend and the potential for continued payout hikes should help Broadcom remain one of the more appealing dividend tech plays over time.