The qualifications for great dividend stocks are relatively simple. It involves a strong business that generates more cash than it knows what to do with and management that is determined to give some of that excess cash to shareholders as a "thank you" for owning a piece of the company. The trick to great dividend stocks is being a company that can keep paying and raising its dividends year after year, through good economic times and bad.
Semiconductor company Texas Instruments (TXN 1.06%) is showing clear signs that it has the qualifications to be a great dividend payer. The company's dividend yields a solid 2.5% at its current share price, and management has raised the payout 18 years in a row, putting it that much closer to reaching Dividend Aristocrat status. But can investors feel confident that Texas Instruments will achieve long-term dividend glory? Let's take a closer look and see if we can answer the question.
What makes Texas Instruments special?
Texas Instruments is a semiconductor company in a crowded field with numerous competitors. So what "secret sauce" does Texas Instruments have that keeps its peers from eating its lunch?
Texas Instruments has built a very profitable business; it specializes in 300-millimeter wafer technology, which it claims has a 40% cost advantage over 200mm technology, a typical chip size among competitors. Additionally, it sells more than 80,000 products across various applications, diversifying the business and preventing a single adverse event from hurting the company too greatly.
Texas Instruments' ability to innovate and bring so many products to market has enabled the company to grow as technology evolves and semiconductors see more demand over time. Texas Instruments has 15 manufacturing facilities worldwide, which means that it controls every step of bringing a new product to market, from development to production.
You can see in the above chart how the company's free cash flow has steadily grown over the years, with only minor hiccups due to increased investments to build factories from time to time. A business needs to have a reliable and steady cash flow to afford a dividend and repeatedly raise it. Texas Instruments has grown its free cash flow per share by 12% annually from 2004 to 2021.
How safe is the dividend?
The best dividend is a consistent dividend, so reliability is a high priority for dividend investors. The chart below shows the financials behind the dividend itself. You can see the dividend payout ratio, which shows how much of the company's cash flow goes toward the dividend. With a 61% payout ratio, Texas Instruments still has plenty of cash left after cutting the check to shareholders. It's only when the ratio consistently starts climbing about 70%-75% that investors need to pay more attention to how the company is doing.
But let's say that disaster struck, and the company's cash flow went to zero overnight. Texas Instruments has nearly $10 billion in cash and short-term investments on its balance sheet. It's paid out about $3.9 billion in total dividends over the past year, so the company has enough cash to maintain its dividend for more than two years as it resolves whatever issue caused the cash flow drop. That suggests solid dividend security.
What does the future hold?
I actually expect Texas Instrument's free cash flow to grow over the long term. The company has more than 100,000 customers across the world but focuses on three significant end-markets, including industrial (41% of revenue), automotive (21%), and personal electronics (24%).
The rise of 5G and broader communication technology could fuel new growth in these industries. Uses such as electric vehicles, autonomous vehicles, and connected industrial devices and machines should contribute to the ongoing demand for semiconductors, which are the building blocks of technology. For example, the global industrial automation market could grow 10% annually through the end of the decade.
As long as Texas Instruments can keep innovating and bringing new products to market, the company seems poised to thrive and continue putting cash in shareholders' pockets.