We've taken a look at how relative valuation techniques apply to Texas Instruments
Discounted cash flow valuation
If you rely on a dividend discount model, you generally assume that the company is paying out as much in dividends as it can afford to, and putting business growth on the back burner. But with discounted cash flows, you're looking at how much moola the company generates for its shareholders in total, whether it's then reinvested into the business, paid out as dividends, or simply put back in the bank. Texas Instruments generates copious amounts of free cash flow, so this method should give us more granularity and fewer mood swings.
I'm using a 10% discount rate -- more on that in a minute. Assume 16% growth for the first five years, then 10% for then next half-decade, and 4% a year after that, starting from $1.2 billion of annual free cash flow. The company currently has 1.44 billion shares outstanding.
With these inputs, Texas Instruments is worth about $41.8 billion, or $29 per share. It's a mere 5.7% discount to today's $30.70 per share.
Risk and rewards
So here's the really tricky part. How do you estimate those risk premiums? How about growth rates? No matter which valuation model you choose, you need to be reasonably close to reality with both of those estimates, or your end results will be misleading.
For example, I could go with the analyst consensus earnings growth for the next five years, which is 15%, and adjust the intermediate period down to 7%. Then, Texas Instruments is 22% overvalued today.
Conversely, analysts think the company will grow earnings by 35% next year. Take that as gospel for five years, just for kicks, and adjust the mid-term rate to about 13%, and there's a 54% bargain on the table.
For my calculations, the 16% initial growth was an amalgam of analyst estimates, historical growth, and educated guesswork. Two out of those three components are highly subjective.
The risk premium was another considered guesstimate, starting from the 12% discount I'd expect for the average company and lowering that a couple of points to reflect Texas Instruments' competitive advantages, such as flexible manufacturing strategies and commanding market shares in several of its reportable segments.
The Foolish finish
That's a lot of numbers, and a lot of guesswork. But these are the kinds of calculations on which the entire stock market is based. We need some way to estimate what our investments are worth, and all of these tools we covered in this series come in handy in various situations.
For Texas Instruments, it seems best to go with the multi-stage DCF model. The company has nice, positive cash flows to form a starting point, but pays out only 17% of FCF in dividends. We've seen how the Dallas humdinger has a vastly different operating model from its peers, as well as from itself five years ago, so relative valuation ratios make an awkward fit.
And Gordon Growth is nice for stable, mature companies like Campbell Soup or Atlanta Gas Light, but a more flexible model comes in handy when you're looking at moderate-to-high growth businesses like Texas Instruments, Google, or Comcast.
Depending on your risk estimates and growth expectations, then, Texas Instruments is worth between $25.30 and $33.00 per share today. Either way, it's no great bargain, and at the lower end of these estimates, it's downright pricey. Feel free to do your own math and tell us what you think in Motley Fool CAPS.
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Fool contributor Anders Bylund holds no position in any of the companies discussed here. You can check out Anders' holdings if you like, and Foolish disclosure is worth its weight in recycled electrons.