Demand in the storage and chip industries has been slow over the last year, which has weighed on revenue and earnings at Seagate Technology (NASDAQ:STX) and Texas Instruments (NASDAQ:TXN). But both companies are well positioned to meet rising demand over the long term in their respective markets.

Over the last year, both stocks have climbed nearly 30%, as investors look past the near-term obstacles to an eventual pickup in demand. We'll compare both to see which one has the better chance to outperform over the next few years.

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Image source: Getty Images.

Where's the growth at Seagate?

Seagate has experienced a steady decline in revenue in recent years, stemming from competitive pressure in the consumer market for desktop and notebook storage drives. There has never been a better time to upgrade the hard drive in your computer, as prices continue to get cheaper. But that has taken a severe toll on Seagate's top line. Over the last five years, revenue has fallen 27% to $10.4 billion. 

The situation may reverse in the near future. The consumer market is gradually declining as a percentage of Seagate's business (18% as of the most recent quarter). The main engine of growth is expected to come from enterprise and cloud providers, which made up 41% of total revenue in the last quarter. Seagate sees demand for mass-capacity storage drives rising at double-digit rates over the next five years, as enterprise and cloud companies continue to invest heavily in data center capacity. 

Revenue is down just 5% over the last three years, but Seagate has kept earnings per share up by repurchasing shares. EPS climbed 23% over the last year, which has kept the stock price afloat. Analysts expect revenue to be slightly down this year and next, while earnings are expected to improve to $5.03 per share in 2020. 

Texas Instruments has the cash

Texas Instruments (TI) is known for making analog and embedded processors for a range of electronic devices, but the chip manufacturer sees a bright future making processors for more high-growth markets like automotive and industrial applications. These markets make up most of TI's business, which management favors for their faster growth and higher margins. 

The chip industry has been in a slowdown since last fall, which has caused TI's revenue to drop for three quarters in a row. But this shouldn't last long, given the secular demand trends for increasing chip content in cars and other industrial uses. Analysts are anticipating a recovery next year, with revenue expected to be up 5%. 

Although TI has experienced a decline in revenue this year, it has been more consistent at growing revenue than Seagate. This highlights the fact that Seagate operates in a highly competitive and cyclical industry, whereas TI makes chips for several markets. The breadth of its product portfolio is one of its competitive advantages and is a reason why the company has steadily grown over the years. 

The one thing that really stands out when comparing the two is TI's steady increase in gross margin and free cash flow. Both companies pride themselves on allocating capital to the markets with the best returns in their respective industries to maximize long-term free cash flow. But, as evident in this chart, TI has been much better at accomplishing this: 

STX Free Cash Flow (TTM) Chart

STX Free Cash Flow (TTM) data by YCharts. TTM = trailing 12 months.

The chipmaker generates a free cash flow margin of 39% of revenue, which is almost four times the margin of Seagate. TI attributes this performance to its low-cost manufacturing strategy and advanced technology. Recently, the company has been transitioning to 300-millimeter wafers, which are more cost-effective to produce than 200-millimeter.

Consistency or value?

I believe Texas Instruments is the better business, but Seagate is the better value.

Seagate has headwinds to overcome. Even if the company experiences robust demand from the enterprise market over the next few years, it's still nursing a declining consumer market. Consumer storage products generate healthy margins, but the growth in enterprise may be mostly offset by a decline in storage demand for desktops and notebooks. Therefore, revenue probably won't advance by very much. 

There's also the question of how much investment will be required to meet rising enterprise demand. Seagate ramped up its capital expenditures significantly last year to $602 million, nearly double the previous year. That contributed to a decline in free cash flow of 34%. Management plans to continue spending to increase capacity to meet expected demand, but that could eat into the bottom line. Nonetheless, analysts expect Seagate to grow earnings by 7.7% annually over the next five years. 

On the other side, analysts expect TI to grow earnings by 10% annually. The stock price has tripled over the last five years, but that leaves TI trading at a relatively high valuation. Here's how both stocks measure up:

Metric Seagate Technology Texas Instruments
Market cap $14.46 billion $120.87 billion
Forward P/E 10.88 22.40
Forward dividend yield 4.68% 2.77%
Five-year expected annual earnings growth 7.74% 10.00%

Data source: Yahoo! Finance. Earnings growth based on the consensus analyst estimate. 

A year ago, I sided with Texas Instruments over Seagate. Since then, TI stock is up 36%, versus Seagate's return of 28%. Income investors may be tempted by Seagate's low valuation and high dividend yield, but investors should keep in mind that Seagate could be more volatile than Texas Instruments.

With Texas Instruments, investors get a company that has been around for decades. It's proven and tested through all economic cycles, and it pays an above-average dividend yield of 2.77%. 

Seagate's investments in enterprise products may pay off, but I want to see further evidence that its strategy is working before buying the stock. Therefore, I still believe Texas Instruments is the better buy.