This Chipmaker Is an Excellent Stock to Hold Despite Recent Weakness

The last quarter might not have been great for this chip-making bellwether, but the future looks quite strong.

Jan 8, 2014 at 1:30PM

Texas Instruments (NASDAQ:TXN) has continued to rise over the past few months even though it is seeing weakness in its end markets. The stock is already trading close to its 52-week high and at stretched valuations, pretty much like its semiconductor peers such as Analog Devices (NASDAQ:ADI) and Atmel (NASDAQ:ATML).

What's even more surprising is the fact that Texas Instruments shares have gained despite a poor outlook issued by the company the last time it reported earnings. The company's book-to-bill ratio was below 1 in the last-reported third quarter, indicating that it is seeing weak order patterns.

Management cited seasonal declines in orders as the reason behind the weak outlook. In addition, it looks like customers used the existing inventory that they had built up earlier in the year, leading to further weakness for Texas Instruments. Under such circumstances, investors might have to question if it is prudent to hold on to Texas Instruments, especially considering that yet another weak outlook later this month could spell trouble.

End-market cues
Texas Instruments is expected to report its fourth-quarter results on Jan. 21 and all eyes will be on the guidance. With a good portion of the revenue coming from the industrial and the automotive end markets, there might be some good news in store for Texas Instruments' investors.

According to KPMG's annual global semiconductor industry outlook, semiconductor industry executives are expecting good demand in 2014. KPMG put the confidence index of the industry at 57, and the firm considers a reading above 50 as a positive sign. Executives are cautiously optimistic about the trends in the industry this year, but sub-sectors such as medical devices, industrial machinery, and automotive are expected to perform well.

In addition, Semiconductor Intelligence expects growth to accelerate in 2014, driven by the increase in global GDP. The research firm projects that the semiconductor market will grow as much as 15% this year, on the basis of the International Monetary Fund's GDP growth forecast. Texas Instruments is a bellwether in the semiconductor industry, as its chips are used across a variety of applications. As such, investors can expect the company to gradually gain momentum as the year progresses on the back of demand in key areas, such as automotive and industrial.

For example, new vehicle sales in the U.S. are expected to reach their highest levels this year since 2006. According to Edmunds.com, sales are expected to hit 16.4 million vehicles in 2014, up from 15.6 million last year.  

Additionally, according to the Manufacturers Alliance for Productivity and Innovation (MAPI), the U.S. industrial outlook for 2014 and 2015 is looking good. Manufacturing production is expected to increase 3.1% this year, better than the 2.1% growth seen last year. High-tech production -- computers and electronic products -- is expected to increase 6.8%, while traditional manufacturing is projected to improve 3%, better than last year's growth rates of 4.4% and 2%, respectively. 

There were positive cues from peers in the industrial market, as well. For instance, Atmel saw growth in the industrial market and is upbeat about prospects going forward. Atmel is seeing robust adoption of its touchscreen controllers in the industrial and automotive markets. Atmel's maXTouch controller was chosen by Japanese company Kyocera for a medical device, and the company has landed design wins at the three largest auto makers in North America and Europe.

Reasonable valuation
Given these projections, investors should consider holding on to Texas Instruments for the time being and seeing if the company offers an optimistic outlook for the current fiscal year. Some might think that the stock is fairly valued at 25.6 times earnings, but a forward P/E of 20 indicates that earnings growth is expected.

Also, when compared to industry peer Analog Devices, which trades at a P/E of 23.2, Texas Instruments doesn't appear to be all that expensive. Analog Devices is also seeing weakness in the end markets, leading to a weak outlook for the current quarter. The stock had to face a couple of downgrades, most notably from Wells Fargo, but analyst firm B. Riley is of the opinion that recent weakness could be an opportunity to buy Analog Devices. 

The bottom line
Considering the long-term opportunity present in the semiconductor industry, it might not be a good idea to sell chipmakers such as Texas Instruments and Analog Devices. Moreover, Texas Instruments has an impressive dividend yield of 2.70% and aggressively returns cash to shareholders. For example, in the third quarter, the company returned $1 billion through dividends and stock repurchases.Even though Texas Instruments' outlook was not very strong the last time, there are some good reasons to hold on to the stock.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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