Altera: Future Dividend Challenger

| About: Altera Corporation (ALTR)
Altera (NASDAQ:ALTR) isn’t a name most income investors are likely familiar with. While I use David Fish’s deservedly popular Dividend Champions list to research dividend investment opportunities, more interesting to me than the Champions (companies that have raised dividends for 25 consecutive years) are the companies Mr. Fish calls Dividend Contenders (10-24 years of increases) and Challengers (5-9 years). Altera technically won't even be a Challenger until next year but gets a mention on the list anyway as it approaches the 5 year milestone. As a younger investor with many years until I start depending on my portfolio for income, I prefer the higher growth rates offered by these up and comers over the more mature old guard.
With a $13.7 billion market cap, Altera is the second largest designer of programmable logic devices (PLD) right behind top competitor Xilinx (NASDAQ:XLNX). Broadly speaking, PLDs are standardized out-of-the box parts that are programmed by the buyer to perform a specific function in a piece of end equipment such as a network router, modem, etc. They’re extremely flexible tools in the design process since they can be reprogrammed over and over again, much like a rewritable disk. According to the Semiconductor Industry Association, programmable logic is one of the fastest growing segments of the business, and for the last few years, sales for PLDs have increased at a greater pace than sales for the overall industry.
With 3-year average earnings growth of 45%, Altera was able to sidestep much of the pain experienced by the chip industry during the recent recession. On April 26, the company continued this hot streak with first quarter earnings rising 46% year over year on revenues up 33%. Chairman and Chief Executive John Daane said:

Despite the anticipated slowdown in first quarter sales following a remarkable 2010 growth year, we experienced double-digit sequential growth in our 40nm-based devices, as these devices are now entering the best part of their growth phase.

40nm is simply a smaller chip size that delivers greater functionality in less area. Their increased popularity is a function of the "smaller is better" movement towards compact mobile devices.
Altera’s return on equity is phenomenal at 46%. Net margin is 40.1 and debt to equity is easy like Sunday morning at .3. Astonishingly, the stock sells for P/E of 18.3. That’s a trailing PEG ratio of .4. Now it’s entirely possible, likely even, that Altera’s growth will slow if the economy slips back into recession (analysts’ five year growth estimate is 17% per annum). But this still means a forward PEG of around 1. Buying high quality growth at a discount to market valuations allows price plenty of breathing room while the company continues to do its thing. Imagine the equity curve like a diaphragm lifting and falling, churning out consistent profits with reduced volatility. This is what growth at a reasonable price is all about.
As for the dividend, the current yield is .5% growing at near 10% annually for the last 3 years. With a low payout ratio of 9% and plenty of free cash flow, the dividend has tons of room to grow. Altera is clearly not a stock for investors seeking current income but for those looking to build a dividend portfolio for the future. A GARP stock with a dividend kicker.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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