Why I Bought Texas Instruments LEAPS

Texas Instruments (TXN) looks very under valued to one independent securities analyst and fairly valued to most others who give the stock hold or neutral ratings.

Technically, the stock looks pretty strong, and options traders seem to be optimistic.

Reuters profiles the company here and Yahoo does the same here.

Morningstar.com gives TXN its highest rating of five stars and estimates its fair value is $46.

Credit Suisse gives the stock a neutral rating and a fair value rating of $30, and the stock has a bearish point and figure price objective of $25.

Reuters Company Research, which is available on some online brokers' web sites, has a neutral rating on the stock. Reuters rates 30% of stocks outperform, 40% neutral and 30% underperform. "Neutral" means the stock will "in the aggregate, outperform stocks rated underperform."

When Morningstar gives a stock five stars, it effectively is saying the market hasn't recognized the value of the stock and, most important, that there is some risk in buying the stock. If everyone agreed with Morningstar on TXN's prospects, it would be trading at the fair value of $46, and it would be a three-star stock. In addition to estimating TXN's fair value, Morningstar says consider buying the stock when it's under $34.50 and selling it when it's around $59.80. In other words, the stock could easily top its fair value, and many stocks do.

That's why there are a fair number of one-star, over-valued stocks. The TXN January 2010 call options with a $35 strike price indicate the stock will touch $38.45 before the options expire. The implied volatility on the options is as low as it's been in 12 months and lower than the historical volatility. That means the options are relatively cheap and might be a good speculation.

So I made a small bet that Morningstar and Texas Instruments' management are right to be bullish and bought the January 2010 35 calls. If the stock drops 7% and or the daily and weekly charts turn negative, I'll sell the calls. Otherwise, I'll sell if they give me a 50% gain or by mid 2009, whichever happens first. When long-term calls are within six months of expiration, time begins to eat away at their value.

The bullish side of the Texas Instruments story is that the company's stock price is relatively low and that it can make its product mix more profitable. The bearish argument is that it is in a very competitive market, as all large companies are, and that its largest customer, Nokia (NOK), is giving some of its mobile phone chip business to others. Nokia accounts for about 15% of TXN's sales. And there are concerns about the strength of the mobile phone market in a slowing world economy.

Here's what makes TXN attractive:

• Morningstar says the three-year expected annualized return is 26.7%.
• PE of 15.5 vs. 19.4 for the S&P 500.
• The PEG ratio (PE/5-year projected earnings growth rate) is only 1.0 vs. 1.4 for the S&P 500.
• Price/book value ratio of 4.1 vs. 4.0 for the S&P 500.
• Price/sales ratio of 3.1 vs. 2.7 for the S&P 500.
• Price/cash flow ratio of 9.6 vs. 13.1 for the S&P 500.
• Return on assets is 21%.
• Return on equity is 28.4% vs. 22% for the S&P 500.
• TXN is trading for 66% of Morningstar's estimated fair value of $46.00, which is 46.7% above Thursday night's close of $31.36.

Investor's Business Daily gives TXN a composite rating on its fundamental strength and stock market momentum of 91, which means the company is stronger than 91% of all publicly-traded stocks. TXN's relative strength is a low 48, its industry group's relative strength is A-, its profitability and stock momentum are a B and its accumulation/distribution rating is a C. After the recent rally in the stock, which is up almost 13% in the last month, the latter rating soon will be a B.

The scary thing about TXN is that its stock price is about where it was seven or eight years ago. The bigger the company has become, the slower it has grown, and the more its price earnings ratio has shrunk. Today, TXN's PE is 15.5, down from 43.3 in 2003 and 84 in 1998. Such PE compression happens to former high fliers. TXN's hourly, daily, weekly and point and figure charts are here. Its close competitors include ST Microelectronics (STM), Analog Devices (ADI), Linear Techology (LLTC), Infineon Technologies (IFX) and Maxim Integrated Products (MXIM). Their charts are here.

Technical analysts will say it's still too early to jump into TXN, and they may be right. Texas Instruments' news releases are here. Transcripts of the company's conference calls with analysts and links to articles about the company and its industry are here.

Full disclosure: Yesterday I bought TXN January 2010 35 calls. I don’t own any of the other stocks mentioned.