Avnet: Excellent 'Total Return' Potential

May 19, 2022 12:01 PM ETAvnet, Inc. (AVT)TDV, XMVM, FOVL, RFV, FXL, KVLE, RWK, SMIG, RNMC, CLSE, FNK, PAMC, OUSM, DES, HSMV

Summary

  • Don't be fooled by Avnet's below-average 2%+ dividend yield on offer.
  • Focus more on the growth potential, which is compelling in this play.
  • Sales growth, ROIC, and growing margins all point to a strong total return in Avnet stock.
  • Looking for a portfolio of ideas like this one? Members of Elevation Code get exclusive access to our model portfolio. Learn More »

Precio de coste y paso de valor

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Dividend Yield v. Dividend Growth

Many income-derived investors make the mistake of focusing too much on the prevailing dividend yield of a company to the detriment of other information. This strategy is especially prevalent in today's high-inflation market as investors scramble to protect the purchasing power of their portfolios. The problem with this approach is that the current prevailing yield only really tells you what is happening with the respective stock today. An astute investor, however, will put far more focus on the growth potential of the payout for the following reason.

Take a $100 stock paying a 5% dividend yield (where the annual payout is not growing). This means the annual dividend comes to $5 for every share of stock both for this year and in five years' time. Now, take another $100 stock only paying a 2% dividend. However, if we say this company is growing its dividend by, on average, 20% per year, this means the dividend income (assuming all dividends will be reinvested back into the stock) comes out to be also approximately $5 per share at the end of five years.

However, here is the kicker. Which company do you think will return the most capital gain in their respective stock over the 5-year period? Well, considering the strong double-digit dividend growth rate of company B, I know which company my money would be on...

Suffice it to say, income-orientated investors (especially in the current environment) should be putting far more focus on growth potential instead of the stock´s prevailing dividend yield. This may sound counter-intuitive but now more than ever, the greatest inflation hedge is to own investments that pay higher profits year after year.

Avnet's Dividend

Take Avnet, Inc. (NASDAQ:AVT), for example, which is a U.S. player in the electronic components industry. Although the forward dividend yield of approximately 2.21% will not turn many heads for obvious reasons, the payout has increased by 14.2% over the past 12 months alone. Furthermore, dividend payments over the past four quarters only took up approximately 18% of the company's core net profit, so AVT has plenty of flexibility here going forward if it wants to keep on raising the payout significantly

What will drive AVT's dividend going forward? This all comes down to profits and cash flow. If both of these key metrics are growing, dividend growth (especially given the current pay-out) will certainly follow. Many times, we as investors overcomplicate what is required to realize success long-term. We state this because Avnet creates value for its shareholders by putting capital to work today in order to generate robust returns down the road. This means that when it comes down to it, Avnet´s return on invested capital and top-line sales growth essentially create the company´s cash flows and value after investment cost is factored into the equation.

Q3 Numbers

Top-line sales came in at $6.48 billion in the third quarter, which was an impressive 32% growth rate over the same period of 12 months prior. The more profitable Farnell segment increased year-over-year turnover by 18% to come in at $469 million for the quarter. Furthermore, not only did margins increase in Farnell due to better customer experience, but operating margins also improved in Electronic Components due to stronger pricing and more efficient cost control. Asia, in particular, was a bright spot in the quarter, as better-than-expected results due to strong demand in what usually is a seasonally weaker period pointed to Avent having gained market share in that region.

Value

Suffice it to say, the combination of strong revenue growth and margin expansion is going to continue to increase earnings, which is what shareholders want to see. Furthermore, AVT´s sales and earnings are not expensive at all by any stretch of the imagination. Shares of AVT are now trading with a forward GAAP earnings multiple of under 8 and a forward sales multiple of 0.20. Therefore, investors are definitely not paying through the nose for the growth AVT is experiencing at present.

Sustained Investment

Moreover, given the company's low debt to equity ratio of 0.27 at present, this means AVT does not have to service high-interest payments when proportioned to its earnings. This is crucial, as it enables sustained investment in the business which increases the overall value of the outfit. Avnet´s return on invested capital presently comes in at 10.68, and we would be backing management to keep this metric elevated based on current trends.

Management stated on the recent earnings call, for example, that sustained investments in design tools, digital channels, and engineering continue to bear fruit. Value continues to be added in Farnell, with inventory and e-commerce advances resulting in an ever-improving customer experience. Furthermore, prolonged investment in Farnell has not spiked costs like some may have expected, but quite the contrary. Suffice it to say, as this service continues to scale, we would expect more streamlining from ordering to shipping as well as the expense structure of the business.

Conclusion

Therefore, to sum up, trends with respect to Avnet´s sales, margins and return on invested capital all point to a growing company in years to come. This will result in capital gains in the underlying stock as well as significant increases in the dividend. We look forward to continued coverage.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in AVT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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