Is Texas Instruments Incorporated's Dividend Safe?

Many companies don't pay dividends, instead preferring to use their cash flow to buy back a lot of their own stock or reinvest back in the business. This is particularly true in the technology sector, where companies are often hesitant to pay dividends, and would rather invest for growth to stay ahead of the curve.

But Texas Instruments (TXN 1.29%) is a unique, hidden gem among the other technology stocks. It's a large company, with stable and growing free cash flow. The company has a unique ability to keep producing free cash flow, even in very difficult operating climates. And, Texas Instruments pays a very high dividend for its peer group.

Read on to see why Texas Instruments is a great technology pick for income investors, with a very secure dividend.

Texas Instruments isn't like most technology companies
Texas Instruments is a bit of an outlier when it comes to the technology sector. That's because it is a large, more stable company than many high-flying technology companies with questionable fundamentals and inconsistent profits. Texas Instruments has produced strong free cash flow growth for many years, even during the Great Recession of 2008-2009. Although its free cash flow fell due to lower net income, the company soon recovered thanks to the strength of its business model. Here is a layout of Texas Instruments' annual free cash flow, dating back to 2006:

Source: Company financial statements.

As you can see, Texas Instruments' free cash flow follows a pattern of gradual growth over these years. While the company's free cash flow took a dip in 2008 and 2009, the overall the pattern is clear. I'm inclined to give Texas Instruments a pass for its declining cash flow in those two years, because the entire economy was nearly brought to its knees by the financial crisis, and most companies were posting declines. Nevertheless, from 2006-2013, Texas Instruments' free cash flow increased at a 14% compound annual rate, which is very impressive growth.

Because of its solid growth year after year, Texas Instruments has reached a point of maturity and stability. With its billions in annual free cash flow, Texas Instruments buys back a lot of its stock. This creates value for shareholders, as every share retired by the company allows each remaining share to capture a higher percentage of profits and cash flow. But in addition to share repurchases, Texas Instruments is committed to paying a high dividend yield, which is another unique aspect that separates it from the typical technology stock.

Texas Instruments offers a 2.6% dividend yield based on its recent stock price. The company raised its dividend by 13% earlier this year. Over the past five years, its dividend grew by 23% compounded annually. This kind of growth is a testament to its industry leadership position and commitment to increase shareholder cash returns. At 23% growth every year, your income will double every three years.

Fortunately, this high dividend growth looks sustainable. Texas Instruments only distributed about 40% of its free cash flow over the first nine months of 2014. There's plenty of room for management to expand this cash flow if it wanted to. If not, the company could reduce some of its share buybacks, which totaled $2.1 billion over the first three quarters. Or, alternatively, the company could keep its dividend payout ratio at 40% of free cash flow, and instead rely on organic free cash flow growth to fund future dividend increases. In any case, it seems that 15%-20% annual dividend growth is entirely reasonable.

A technology sector leader in dividend safety
It's easy to be skeptical about buying high-dividend technology stocks. After all, tech stocks are notoriously volatile. Many companies in the technology space do not generate consistent free cash flow, and that's especially true during recessions. And it's also true that we can never say with absolute certainty that a company's dividend is completely safe. Bad things can, and often do happen, even to once-great companies.

But Texas Instruments is a rare find. It generates more than enough free cash flow to pay its 2.6% dividend yield, and management is committed to increasing the dividend each year. As long as the fundamentals support its dividend program, Texas Instruments' dividend is secure and should grow at high rates over time.