Shares of Texas Instruments (NASDAQ:TXN) rallied 7% on Jan. 24 after the chipmaker posted its fourth quarter earnings. TI's revenue fell 1% annually to $3.72 billion, which missed estimates by $30 million. But its EPS (which included a one cent tax benefit) nearly quadrupled to $1.27 per share, clearing estimates by three cents.

For the first quarter TI expects its revenue to fall 4%-12% annually, and for its EPS to drop 0%-15%. Analysts had expected TI's revenue to decline 5% and for its earnings to stay flat. Those numbers were clearly mixed, so why did TI's stock rally so sharply?

A graphical depiction of a computer chip.

Image source: Getty Images.

Digging deeper into TI's fourth quarter

TI generates its revenue from three main divisions -- analog, embedded, and other chips. Here's how those three businesses fared during the fourth quarter:

 

Revenue

YOY growth

Operating profit

YOY growth

Analog

$2.64 billion

4%

$1.23 billion

4%

Embedded

$791 million

(12%)

$234 million

(24%)

Other

$288 million

(10%)

$49 million

(28%)

Source: TI Q4 earnings report.

The growth of TI's analog business was supported by robust demand for 5G chips and other signal chain and power chips. TI's transition from 200mm to 300mm wafers, which reduced production costs by about 40%, contributed to its steady growth in operating profits.

Demand for TI's embedded chips waned across multiple markets, as sales of both its processors and connected microcontrollers declined. But during the conference call, VP Dave Pahl noted that it wasn't "unusual for analog and embedded to perform differently in the short-term," and stated that they would be "more consistent in the long term."

TI's gross and operating margins also contracted year-over-year, primarily due to lower revenue growth, fewer factory loadings, and higher R&D expenses. TI's earnings forecast for the first quarter indicates that those headwinds will likely persist.

 

Q4 2017

Q4 2018

Gross margin

65.1%

64.8%

Non-GAAP operating margin

41.7%

40.8%

Source: TI Q4 earnings report.

The headwinds and tailwinds

Two main headwinds also throttled TI's growth during the fourth quarter. First, Pahl admitted that demand for its chips in China "was weaker" than in other regions, primarily due to trade tensions. Pahl also declared that chip distributors, particularly in Asia, became "more cautious" about holding their inventories toward the end of the quarter.

Second, soft demand for smartphones throttle its sales of chips for personal electronics. TI provides chips for a wide range of smartphone makers, including Apple (NASDAQ:AAPL), which slashed its guidance in early January on weak iPhone demand. TI provides battery charging ICs and DC converters for the latest iPhones, but it isn't as heavily exposed to Apple as other suppliers.

A woman uses an iPhone XS Max.

Image source: Getty Images.

On the bright side, TI's sales to telecom equipment end-markets rose about 20% annually on more aggressive 5G infrastructure deployments, and it expects that momentum to continue for the foreseeable future.

The automotive and industrial markets, which accounted for over half of TI's revenues in 2018, both generated positive single-digit annual growth during the quarter -- although both segments posted single-digit declines on a sequential basis.

Staying shareholder friendly

TI's sales and earnings growth looks bumpy, but it remains committed to returning more than 100% of its free cash flow (FCF) to its shareholders. TI generated $6.06 billion in FCF in 2018, representing a 30% increase from 2017. Yet it returned $7.66 billion to shareholders through buybacks and dividends.

In 2018, TI spent 42% of its FCF on its dividend, which it's raised annually for 15 straight years. It also reduced its total share count by 4% for the year. TI reduced its share count by 45% since 2004.

Those moves help TI maintain a reasonable forward P/E of 18 and an attractive forward dividend yield of 3.2%. Analysts expect TI's revenue and earnings to both dip about 2% in fiscal 2019, but TI's legacy of shareholder friendly moves could convince long-term investors to ride out the near-term headwinds.

Is it time to buy Texas Instruments?

Texas Instruments has a better diversified, less capital-intensive, and more shareholder-friendly strategy than many other major chipmakers. But its growth remains soft, and its stock mainly rallied because its numbers weren't as bad as some investors had feared.

I think TI is one of the safer semiconductor stocks, and it remains a sound long-term investment. However, investors looking for low valuations and high yields should probably stick with more bear-friendly consumer goods plays instead of this cyclical tech stock for now.

Check out the latest Texas Instruments earnings call transcript.