Texas Instruments: Why You Should Buy This Fantastically Managed Tech Stock

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About: Texas Instruments Incorporated (TXN)
by: Robert & Sam Kovacs
Summary

Texas Instruments has a stellar record of increasing earnings, cash flows, and dividends.

Management is extremely committed to returning all free cash flow to shareholders, which testifies of their confidence in the business model.

The company is impeccably run, has great financial strength, a reasonable valuation, and exerts great price momentum.

Written by Sam Kovacs

Introduction

Those who know our style of investing know that we don't usually invest in low yielding tech dividend stocks. But with Texas Instruments (TXN), I can only make an exception. Not only does the company operate in an industry with much growth potential, it also has one of the most shareholder friendly management teams out there.

Texas Instruments Incorporated has a dividend yield of 2.42% and trades around $127.10. Based on my M.A.D. Assessment, TXN has a Dividend Strength score of 98 and a Stock Strength score of 86.

This article will present and discuss the factors which show why I believe that dividend investors should invest in Texas Instruments Incorporated.

Source: mad-dividends.com

Texas Instruments Incorporated operates through two segments: Analog & Embedded Processing.

Source: Open Domain

This article will first analyze the merits of TXN as an income producing investment. It will then consider the stock's potential for capital appreciation.

Dividend Strength

Low yielding stocks need to tick multiple boxes to be considered strong dividend stocks. They need to be both able and willing to increase their dividend at an attractive rate. This means they need to be able to easily cover the dividend, and they need to prove that they can grow revenues, earnings and cash flow for the upcoming years.

Dividend Safety

54% of Texas Instruments Incorporated's earnings are paid out as dividends. This is a more attractive payout ratio than 34% of dividend stocks.

TXN pays 39% of its operating cash flow as a dividend, putting it ahead of 31% of dividend stocks.

Texas Instruments Incorporated has a free cash flow payout ratio of 48%, a better ratio than 47% of dividend stocks.

Texas Instruments Incorporated’s dividend coverage is satisfying.

30/06/2015

30/06/2016

30/06/2017

30/06/2018

30/06/2019

Dividends

$1.3200

$1.4800

$1.8800

$2.3600

$2.9300

Net Income

$2.77

$2.97

$4.07

$4.36

$5.46

Payout Ratio

48%

50%

47%

55%

54%

Cash From Operations

$3.88

$4.38

$4.64

$6.60

$7.50

Payout Ratio

34%

34%

41%

36%

40%

Free Cash Flow

$3.34

$3.72

$4.04

$5.65

$6.05

Payout Ratio

40%

40%

47%

42%

49%

Source: mad-dividends.com

While the dividend has more than double during the past 5 years, payout ratios have only increased by 25%. While the dividend is increasing faster than the company’s earnings and cash flows, investors shouldn’t be alarmed. Texas Instruments has been committed to returning all of the company’s free cash flow to shareholders through dividends and buybacks. The fact that the dividend is representing a growing amount of free cash flow implies that a higher percentage of cash returned to shareholders comes in the form of a dividend. Considering that we are in the late stages of the business cycle, this seems reasonable.

Furthermore, TXN can pay its interest 42 times, which is better than 93% of stocks. This level of coverage can be considered fantastic. There is virtually no chance that servicing debt will impair the company’s ability to pay a dividend.

Looking at payout and coverage ratios together would suggest that TXN’s dividend is super safe. The company keeps growing cash flows and earnings, has an exceptional track record of increasing the dividend, making a dividend cut or freeze in upcoming years virtually impossible.

Dividend Potential

Texas Instruments Incorporated's dividend yield of 2.42% is better than 50% of dividend stocks. With sub 2.5% yields, I’m looking for double-digit dividend growth potential.

Source: mad-dividends.com

This last year, the dividend grew 24%, which is slightly higher than their 5-year CAGR of 21%. Since 2004, the dividend has increased by a factor of 35.

Source: mad-dividends.com

Needless to say, this level of dividend growth is fantastic, and the fact that management is committed to increasing the quarterly payout by such a high amount year in year out shows total confidence in their business model.

Over the previous 3 years, Texas Instruments Incorporated has seen its revenues grow at a 6% CAGR and net income by a 20% CAGR. Throughout the whole business cycle, TXN has been able to increase its earnings and revenues.

Source: mad-dividends.com

The semiconductor industry is extremely cyclical. Yet between 2010 and 2013, when the company’s revenues decreased for 3 straight years, the dividend still more than double throughout those three years.

Source: mad-dividends.com

Therefore, the decline in revenues and operating profits which the company experienced in the latest quarter shouldn’t worry investors, and simply viewed as a temporary macro headwind.

The IoT revolution will keep providing a steady stream of business for Texas Instruments in upcoming years.

If the company can continue to grow its revenue and net income at the current rate, TXN’s dividend has great potential for dividend growth.

Dividend Summary

The combination of the data presented above gives TXN a dividend strength score of 98/100. When considering stocks with relatively low dividend yields, I need to see great dividend coverage, and rapid growth in top and bottom lines. TXN ticks all those boxes. Management is super committed to increasing dividends every year, and I expect a 20% increase in dividends at the end of the year.

Stock Strength

Okay, TXN looks like the perfect low yielding dividend stock. It operates in an industry which has massive tailwinds in the next decade, has great dividend coverage and a management team which is extremely committed to increasing dividends. But is now the right time to buy? Technology stocks historically haven’t been the best performers during the late stages of the business cycle and throughout recessions. Yet, this time, around, tech stocks have continued to perform very well throughout 2019. Many would jump to the conclusion that no good opportunities exist in tech right now. Is that the case? To answer that question, I will analyze four fundamental factors: value, momentum, financial strength, and earnings quality.

Value

  • TXN has a P/E of 23.28x
  • P/S of 7.95x
  • P/CFO of 16.93x
  • Dividend yield of 2.42%
  • Buyback yield of 4.41%
  • Shareholder yield of 6.63%.

These values would suggest that TXN is more undervalued than 55% of stocks. TXN’s ttm PE ratio is slightly above that of the S&P 500 which trades at 22x earnings. Yet, the company’s multiple is below that of the tech sector, as you can see in the table below.

Company

Sector Average

Value Score

54.72

38.01

Price Earnings

23.28 x

31.27 x

Price Sales

7.95 x

2.68 x

Price Cash From Operations

16.93 x

20.82 x

Div Yield

2.42 %

1.66 %

Buy back Yield

4.41 %

-0.60 %

Share Holder Yield

6.84 %

-0.33 %

Source: mad-dividends.com

Furthermore, the stock boasts an impressive 4.41% buyback yield. Buying back shares decreases both the dividend payout ratios and the stock’s multiples. This should be an added source of returns for investors.

Source: mad-dividends.com

However, the chart above suggests that TXN is trading slightly above its 5-year average PE. The price discounts the anticipation for an increase in earnings given the stock’s forward PE of 17x.

This would suggest that the stock is fully priced, given the current fundamentals, and increases in price over the next few quarters will have to come from continued momentum and increases in earnings.

Value Score: 55/100

Momentum

Stocks which have increased the most in the past 3, 6 and 12 months usually continue to outperform the market.

Texas Instruments Incorporated's price has increased 14.33% these last 3 months, 21.21% these last 6 months, and 17.19% these last 12 months and now currently sits at $127.10.

Source: mad-dividends.com

TXN has better momentum than 90% of stocks, which is excellent. However, as readers will notice in the chart above, TXN followed the market in its descent during the last quarter of a recession. While I expect TXN to continue beating the market throughout the late stages of the business cycle, when a recession hits, I wouldn’t be surprised to see the stock suffer as much, or even slightly worse than the whole index. For context, between October 2007 and March 2009, the stock lost 60% of its value while the S&P 500 lost 56%.

Momentum score: 90/100

Financial Strength

TXN's gearing ratio of 1.0 is better than 63% of stocks. Texas Instruments Incorporated's liabilities have increased by 13% this last year. Operating cash flow can cover 80.4% of TXN's liabilities. These ratios would suggest that Texas Instruments Incorporated has better financial strength than 85% of stocks. The extremely low gearing ratio, and high interest coverage suggests that TXN can withstand any storm. It is in the top 15% of all US stocks for financial strength which will drive long term returns for shareholders.

Financial Strength Score: 85/100

Earnings Quality

Texas Instruments Incorporated’s Total Accruals to Assets ratio of -6.7% puts it ahead of 44% of stocks. 52.8% of TXN's capital expenditure is depreciated each year, which is better than 18% of stocks. Each dollar of TXN's assets generates $0.9 of revenue, putting it ahead of 69% of stocks. Based on these findings, TXN has higher earnings quality than 42% of stocks. TXN’s asset turnover is satisfying, showing that the company’s asset base is efficient at generating large amounts of revenue. The stock’s negative accruals should be marginally accretive to earnings. The only questionable metric is the rate at which the company depreciates its CAPEX. This low level of depreciation could lead to unexpected writedowns or writeoffs down the line.

Earnings Quality Score: 42/100

Stock Strength Summary

When combining the different factors of the stock's profile, we get a stock strength score of 86/100 which is encouraging. The stock exerts great momentum and financial strength. Its valuation is reasonable, despite not offering a bargain. Given the company’s growth prospects and exceptional management, this seems fair.

Conclusion

With a dividend strength score of 98 & a stock strength of 86, Texas Instruments Incorporated is a great choice for dividend investors. While I didn’t believe I would be adding more tech stocks to my portfolio at the current stages of the cycle, the exceptional outperformance of some of my utility positions has pushed me to rebalance my portfolio earlier than expected as their weight has gone over my target allocation. Some of this excess cash will go towards buying some TXN, as I believe it could be the best managed tech dividend stock available.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TXN 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.