Texas Instruments (NASDAQ:TXN) has performed much better than the chip industry so far in 2022. TXN has a total return of -11.8% for the YTD vs. -40.4% for the semiconductor industry as a whole (as calculated by Morningstar) and -37.7% for the iShares Semiconductor ETF (SOXX). TXN is the largest holding in SOXX, making TXN’s relative performance even more notable. For context, the S&P 500 (SPY) has returned a total of -21.1% for the YTD. TXN is currently trading $157.73, 21.6% below the 12-month high closing price of $201.29 on October 21, 2021.
12-Month price history and basic statistics for TXN (Source: Seeking Alpha)
TXN has grown earnings at a steady clip over the past 3 years, consistently beating analyst expectations. In the most recent earnings report on July 26th, for Q2 of 2022, quarterly EPS exceeded the consensus expected value by 15.7%. The rate of earnings growth has slowed over the past year, and the outlook is for 2023 earnings to fall below the 2022 results. The consensus expectation for EPS growth over the next 3 to 5 years is a modest 6.1% per year.
Historical (3 years) and estimated future quarterly earnings per share ('EPS') for TXN. Green values are amounts by which the quarterly EPS beat the consensus expected value (Source: ETrade)
With TXN’s price decline, the shares look reasonably valued relative to current and expected earnings. The forward and TTM P/E are 17.3 and 17.0, respectively, on the low end of TXN’s P/E range over the past 4+ years. This makes sense given the low expected growth rate, however.
Income investors should note that the rapid dividend growth in recent years is higher than the expected earnings growth in the next several years. The trailing 3-, 5-, and 10-year dividend growth rates are 14.3%, 18.1%, and 21.1% per year, respectively. With expected EPS growth of 6.1% per year, maintaining anything close to historical dividend growth rates will push up the payout ratio (currently at 47.6%). The current payout ratio is somewhat below TXN’s 5-year averages, 57.2% (GAAP) and 54.6% (non-GAAP), so there is some room for an increase. That said, in difficult economic periods, companies may prefer to build up some cash reserves and strengthen their balance sheets rather than raising the payout ratio. TXN’s board recently approved an additional $15B in buybacks, which will constrain dividend growth rates. For income investors, buybacks tend to increase the relative attractiveness of selling covered calls relative to dividends.
I last wrote about TXN on July 27, 2021, about 14 months ago, at which time I assigned a buy rating on the shares. Since the close on July 27th, TXN has returned a total of -12.5% vs. -16% for the S&P 500 and -25.2% for the iShares Semiconductor ETF. I calculated these results using dividend-adjusted closing prices from Yahoo! Finance and current trading prices TXN, SPY, and SOXX.
Previous analysts of TXN and subsequent performance vs. the S&P 500 (Source: Seeking Alpha)
For my July 27, 2021 analysis, TXN’s valuation was a concern, but the strong earnings growth track record and EPS growth consistently above expectations helped to offset this issue. The Wall Street consensus rating for TXN was a buy, and the consensus 12-month price target was 9.2% (Seeking Alpha) to 12.7% (ETrade) above the share price at that time. I also rely on a probabilistic outlook derived from the prices of call and put options on a stock, the market-implied outlook, which represents the consensus view among buyers and sellers of options. The market-implied outlook to early 2022 was bullish, with expected volatility of 27% (annualized). As a rule of thumb for a buy rating, I want to see an expected total return that is at least ½ the expected volatility. Taking the Wall Street consensus price targets and adding the dividend (for a total return range of 11.4% to 14.9%), TXN reached that threshold at the higher end of the consensus range. Considering the company’s robust earnings track record and the bullish views from the Wall Street consensus and the market-implied outlook, I assigned an overall buy rating.
For readers who are unfamiliar with the market-implied outlook, a brief explanation is needed. The price of an option on a stock is largely determined by the market’s consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of call and put options at a range of strike prices, all with the same expiration date, it is possible to calculate a probabilistic price forecast that reconciles the options prices. This is the market-implied outlook. For a deeper explanation and background, I recommend this monograph published by the CFA Institute.
I have calculated updated market-implied outlooks for TXN and compared these with the current Wall Street consensus outlooks in revisiting my rating.
ETrade calculates the Wall Street consensus outlook for TXN using ratings and price targets from 19 analysts who have published their views over the past 3 months. The consensus rating is a buy, as it has been for almost all of the past year. The consensus 12-month price target is 14.7% above the current share price. There is a high dispersion among the individual analyst price targets, reducing confidence in the predictive value of the consensus.
Wall Street analyst consensus rating and 12-month price target for TXN (Source: ETrade)
Seeking Alpha’s version of the Wall Street consensus outlook combines the views of 31 analysts who have published price targets and ratings over the past 90 days. The consensus rating is a hold, having shifted from a buy in early 2022. The consensus 12-month price target is 15.3% above the current share price.
Wall Street analyst consensus rating and 12-month price target for TXN (Source: Seeking Alpha)
Even though ETrade and Seeking Alpha calculate different consensus ratings for TXN, the consensus 12-month price targets are very close. With a consensus price target that is 15% above the current share price and the 3% forward dividend yield, the expected 12-month total return is 18%.
I have calculated the market-implied outlook for TXN for the 3.7-month period from now until January 20, 2023 and for the 8.5-month period from now until June 16, 2023, using the prices of call and put options that expire on these dates. I selected these two dates to provide a view to the start and middle of 2023, as well as because the options expiring in January and June tend to be among the most liquid. The trading volume for the June options is much lower than for the January options, reducing the relative weight that I give to the 8.5-month outlook.
The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Market-implied price return probabilities for TXN for the 3.7-month period from now until January 20, 2023 (Source: Author’s calculations using options quotes from ETrade)
The market-implied outlook for the next 3.7 months is generally symmetric, with comparable probabilities of positive and negative returns. The expected volatility calculated from this distribution is 36.5% (annualized) as compared to 27% in my last analysis. Most, if not all, of the increase in expected volatility is due to broader market conditions, with the VIX increasing substantially over the past year.
To make it easier to compare the relative probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).
Market-implied price return probabilities for TXN for the 3.7-month period from now until January 20, 2023. The negative return side of the distribution has been rotated about the vertical axis (Source: Author’s calculations using options quotes from ETrade)
This view shows that the probabilities of positive returns are consistently higher than the probabilities of negative returns of the same size (the solid blue line is above the dashed red line over almost all of the chart above). This is a bullish tilt in the market-implied outlook.
Theory indicates that the market-implied outlook is expected to have a negative bias because investors, in aggregate, are risk averse and thus tend to pay more than fair value for downside protection. There is no way to measure the magnitude of this bias, or whether it is even present, however. The expectation of a negative bias reinforces the bullish interpretation of this outlook.
The market-implied outlook to the middle of 2023, calculated using the prices of options that expire on June 16, 2023, has a smaller bullish tilt than the short-term outlook. The expected volatility calculated from this outlook is 35.3% (annualized).
Market-implied price return probabilities for TXN for the 8.5-month period from now until June 16, 2023. The negative return side of the distribution has been rotated about the vertical axis (Source: Author’s calculations using options quotes from ETrade)
The market-implied outlooks to mid-January and to mid-June of 2023 are bullish, although the bullish tilt is less pronounced for the longer outlook. The expected volatility is stable at about 35% to 36%. At these high levels of volatility, selling covered calls will provide fairly high income. The bid price for the June 16, 2023 call option with a strike of $175 is $11.05. At TXN’s current price of $158.41 (the price when I pulled the options quotes), selling these calls against a long position in TXN provides 7% in premium income ($11.05 / $158.41) over 8.5 months (9.9% annualized income), while retaining 10.5% of potential price appreciation.
It has been a bleak year for investors holding semiconductor stocks, but TXN has been a bright spot. While the consensus outlook is for an earnings decline in 2023 and slower earnings growth over the next several years, there are reasons to believe that TXN can deliver decent returns to shareholders. The Wall Street consensus rating is a mixed bag. ETrade calculates a consensus buy rating, but Seeking Alpha comes out with a hold for TXN. The consensus 12-month price targets from Seeking Alpha and ETrade are very close, however, indicating an expected total return of 18% over the next year. Even though expected growth is muted, the consensus view indicates solid potential gains from the current reduced share price. Taking the consensus price target at face value, TXN meets my buy threshold for an attractive risk-return, with the expected total return slightly right at ½ the expected volatility (35%-36%). The market-implied outlooks to mid-January and to mid-June are bullish. I am maintaining my buy rating for TXN.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.