Warren Buffett once said, "Only when the tide goes out do you discover who's been swimming naked." As we're seeing now in today's tumultuous market, that usually means profits, specifically, efficient free cash flow.
While the Nasdaq Composite is sometimes associated with high-growth, no-profit stocks, Apple (AAPL -1.22%) and Texas Instruments (TXN -2.44%) are two blue-chip tech stocks that have generated superior long-term returns by producing excellent free cash flow per share. Companies like these two can ballast your portfolio through thick and thin for the long haul.
Superior free cash flow margins
As you can see, both Apple and Texas Instruments generate superior free cash flow margins. In their most recent fiscal years, Apple turned 25.4% of its revenue into free cash flow -- a stunning $93 billion. Meanwhile, Texas Instruments generated $6.3 billion in free cash flow last year, but at an even higher 34.3% margin.
AAPL Revenue (Annual) data by YCharts
Both companies make hardware, which isn't normally associated with high returns on capital. So how do these two all-stars do it?
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The best brand in the world translates to margins and loyalty
It's remarkable how Apple achieves such high margins, considering it operates mostly in computer hardware, which is traditionally a low-margin business. And yet, Apple has become a differentiated platform by developing its own operating system and software, which is seamlessly integrated with its hardware products. That's opposed to its competitors, which usually operate on an industry standard operating system -- Windows for PCs, or Android for phones. Apple has continued this virtual integration in recent years, developing some of its own proprietary semiconductors such as its new M1 laptop processor.
Apple's total control over its products results in a slick, intuitive experience that delights customers. And Apple's marketing, such as its famous "Think Different" ad campaign, positions itself not just as a device maker, but rather as an aspirational brand.
Meanwhile, the development of the iPhone has enmeshed Apple's brand even closer to customers. Given how attached we are to our phones, and how much personal information is stored on it, customers are extremely unlikely to switch operating systems today.
Intense brand loyalty leads to Apple's pricing power; meanwhile, Apple's total control over its supply chain and global scale enables it to keep costs under control, at least relative to competitors. The combination allows for Apple to generate outsized free cash flow.
Relentless focus on free cash flow per share makes it happen for TI
Meanwhile, Texas Instruments is a leader in producing semiconductors, specifically analog chips and embedded microcontrollers, among others. Texas Instruments has a long history going back all the way to 1930. Over time, it's had to develop new products, target new markets, and take advantage of opportunities to get where it is today.
Management goes about this with a singular focus on free cash flow per share. In fact, the company makes an investor presentation every year, in which it outlines its strategy for maximizing free cash flow, while scoring itself on its execution of the prior year's plan.
That free cash flow is the result of several competitive advantages. These include enhancing the longevity and diversity of products, meaning Texas Instruments makes chips that can be used many times over for many years. Although diversified enough to achieve smooth results, TI has focused on auto and industrial chips in recent years. Because cars and factory equipment are becoming more and more automated and digital, requiring more chips in every generation of vehicles and industrial machines, these are great, high-margin growth businesses to be in.
Finally, the company focuses on efficient operating excellence, producing most of its own chips in-house on larger 300mm wafers, which are more cost-efficient than those produced on 200mm wafers.
Free cash flow leads to big shareholder returns
High free cash flow allows both Apple and TI to invest in growth, repurchase shares , and grow their dividends as well. As you can see, each company has bought back lots of its shares over the years, lowering their share counts while raising their dividends impressively over the past decade.
AAPL Average Diluted Shares Outstanding (Annual) data by YCharts
Growing earnings and dividends with a declining share count is a terrific combination over the long-term, which is why these two Nasdaq stocks are safe picks to ballast your portfolio over the long haul.
