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Texas Instruments (NASDAQ:TXN) is a rather interesting company in our coverage universe. The firm has solid fundamentals, so we were a bit surprised to find that its shares are trading above the high end of our estimate of its fair value range (they are overvalued on a discounted cash-flow basis)--it may actually have to do with investors chasing its most recent dividend increase. Still, we think Texas Instruments has solid dividend growth prospects. Even though we'd never invest in a company that's overvalued just because it has strong dividend growth prospects, let's take a deep dive into our dividend analysis for Texas Instruments.

Texas Instruments' Investment Considerations

Texas Instruments' Return on Invested Capital

Texas Instruments' Dividend

(click to enlarge)

Texas Instruments' dividend yield is above average, offering a 3.2% annual payout at recent price levels. We prefer yields above 3% (and growing) and don't include firms with yields below 2% in our dividend growth portfolio. So Texas Instruments fits the bill thus far. But what about its dividend's safety and growth prospects.

We think the safety of Texas Instruments' dividend is good (please see our definitions at the bottom of this article). We measure the safety of the dividend in a unique but very straightforward fashion. As many know, earnings can fluctuate in any given year, so using the payout ratio has some limitations. Plus, companies can often encounter unforeseen charges, which makes earnings an even less-than-predictable measure of the safety of the dividend in any given year. We know that companies won't cut the dividend just because earnings have declined or they had a restructuring charge that put them in the red for the quarter (year). As such, we think that assessing the cash flows of a business allows us to determine whether it has the capacity to continue paying these cash outlays well into the future.

That has led us to develop the forward-looking Valuentum Dividend Cushion™. The measure is a ratio that sums the existing cash a company has on hand plus its expected future free cash flows over the next five years and divides that sum by future expected dividends over the same time period. Basically, if the score is above 1, the company has the capacity to pay out its expected future dividends. As income investors, however, we'd like to see a score much larger than 1 for a couple of reasons: 1) the higher the ratio, the more "cushion" the company has against unexpected earnings shortfalls, and 2) the higher the ratio, the greater capacity a dividend-payer has in boosting the dividend in the future. For Texas Instruments, this score is 1.4, revealing that on its current path the firm should be able to cover its future dividends with net cash on hand and future free cash flow.

Now on to the potential growth of Texas Instruments' dividend. As we mentioned above, we think the larger the "cushion" the larger the capacity it has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. To do so, we evaluate the company's historical dividend track record. If there have been no dividend cuts in 10 years, the company has a nice growth rate, and a nice dividend cushion, its future potential dividend growth would be excellent, which is the case for Texas Instruments.

And because capital preservation is also an important consideration, we assess the risk associated with the potential for capital loss (offering investors a complete picture). In Texas Instruments' case, we currently think the shares are overvalued, so the risk of capital loss is high. If we thought the shares were fairly valued, the risk of capital loss would be medium.

All things considered, we like the potential growth and safety of Texas Instruments' dividend, but we won't be pulling the trigger on an overvalued firm.

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

Source: Texas Instruments Boasts A Strong Dividend But Shares Are Surprisingly Pricey