The beauty of long-term investing is how much you can potentially get out of an investment decades into the future. So for people in early to middle adulthood, it’s not too early to start thinking about retirement income streams 20, 30 or 40 years from now when selecting stocks today.

One of the best ways to ensure a healthy retirement is to invest in high-dividend stocks. These stocks may not look impressive in terms of their current dividend yield, but if a stock can grow its payout above the rate of inflation for many years, the compounding effect can actually provide a comfortable retirement.

Semiconductor equipment manufacturers Applied materials (NASDAQ: AMAT) has a yield of just 0.7% today. But for those with a long-term investment horizon, there are many reasons to believe that those payouts will be significantly higher in five, ten, and twenty years or more.

Growth and efficiency through AI

Of course, for a dividend to grow, a company’s earnings per share must also grow. And the easiest way to increase profits and cash flow is to grow the company efficiently. In this regard, things are looking bright for Applied Materials thanks to several technological developments, including artificial intelligence (AI) and the energy legacy.

Applied Materials is the largest supplier of semiconductor equipment by revenue and one of the most diverse. The company has a strong position in etching and deposition, where it is one of two to three players for critical manufacturing steps. It is also active in metrology and ion implantation machines, among others.

Applied Materials’ leadership position in several areas, including leading-edge technology, laggard technology and memory chips, has given the company the deep knowledge to anticipate and capitalize on market trends. While the semiconductor industry is cyclical, it is a long-term growth industry, and Applied Materials has grown its earnings at a compound annual growth rate of 26% over the past five years.

Although the rise of cloud and AI makes it difficult to continue this success at the company’s size, analysts still expect the company to grow its earnings at a CAGR of 15.6% over the next five years, well above market growth.

Even better, this growth is efficient and does not require excessive capital expenditures, as is the case with many other chipmakers. Applied Materials generates impressive operating margins of nearly 30% and has delivered an impressive return on equity of 43% over the past 12 months.

Applied Materials’ competitive advantage lies in its unmatched technological expertise in the sophisticated art of chip manufacturing, and this research and development expertise is coming into its own in the age of artificial intelligence. The semiconductor industry is just beginning to produce gate-all-around transistors and backside power delivery. The company believes it has invested ahead of these technological disruptions and will gain market share even as these AI-based markets expand in the coming years.

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This is a recipe for strong earnings growth.

A low payout ratio and many buybacks

In addition to earnings growth, another reason why Applied Materials can increase its dividend in the coming years is its very low payout ratio of just 15.3%. This means that today the company only pays out about 15% of its net income as dividends.

Best of all, the company is giving even more money back to shareholders in the form of share buybacks. Last quarter, the company’s $861 million in share buybacks outpaced its $331 million in dividend payments by 2.6 to 1.

So not only does Applied Materials have plenty of room to increase its payout ratio, but its share buybacks also help reduce the number of shares. Over the past year, share buybacks have reduced the number of shares by about 1.2%. That means the company could theoretically increase its dividend per share by 1.2% without increasing the total amount paid out.

Over time, rising earnings combined with a declining share count and a currently low payout ratio will pave the way for strong dividend per share growth.

A dividend tied to this robust segment

Finally, there is a third reason to be pleased about Applied Materials’ dividend growth: Management is linking the payout to profits from the services business, which accounted for 23.3 percent of the company’s sales last quarter and had an operating margin of 29.6 percent.

In a conference call with analysts, Chief Financial Officer Brice Hill said: “We expect our dividend to be supported by earnings from the services business. This gives us confidence that we can increase our dividend in the future.”

Applied Materials’ primary business is selling high-tech equipment, but one downside to the semiconductor business is its cyclical nature. However, the company also attaches service contracts to its machines, which tend to have a much steadier growth trajectory. Hill noted that about 85% of Applied Materials’ service revenue is “recurring” in nature.

This is because service contracts are typically tied to the size of the company’s installed base of machines, even if the company’s machine sales fluctuate. And that existing base typically grows every year, even if machine sales slow down or even decline one year.

Last quarter, Applied Materials reported 5.3% growth in equipment sales but 8% growth in services – the 20th consecutive quarter of growth for that segment. Management noted that the installed base grew 7% year-over-year, but services revenue per chamber grew even more.

Over the long term, Applied Materials expects double-digit growth in this segment. There are reasons to be optimistic: Software now makes up a large portion of service contracts as the company leverages AI from its vast installed base of machines to help customers limit defects and increase yields. Management noted on the conference call with analysts that subscription terms average 2.8 years and have a renewal rate of over 90%.

This gives the dividend a lot of stability and the ability to increase it every year. If Applied Materials is targeting low double-digit growth for the services segment over the long term, investors should expect the dividend increase to follow suit.

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Billy Duberstein and/or his clients hold positions in Applied Materials. The Motley Fool holds positions in Applied Materials and recommends the company. The Motley Fool has a disclosure policy.

Why Applied Materials Is Destined to Be a Great Dividend Growth Stock was originally published by The Motley Fool.