Today's Buy Opportunity: Texas Instruments

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When we kicked off our special "11 O'Clock Stock" series in late July, our first recommendation was Qualcomm (Nasdaq: QCOM), a semiconductor giant that's sure to profit from the boom in mobile devices. I'm not straying too far from that original thesis as my stock pick today is Texas Instruments (NYSE: TXN). The combination of great valuations and various growth catalysts for chip companies makes the entire sector quite attractive, although Texas Instruments is finding several ways to stand out from the crowd.

Texas Instruments fast facts

Source: Capital IQ, a division of Standard & Poor's.
LTM = last 12 months.

Although quite possibly best known for its line of TI educational calculators, Texas Instruments is a semiconductor outfit that has its hands in almost everyone's goody bag. They compete in three chip sectors: analog, embedded processing, and wireless. Analog semiconductors, which help change real-world signals like sound, temperature, and images into streams of digital data, comprise the lion's share of TI's revenues (about 41%). They hold the leading position with 13% market share.

However, TI is extremely diversified, with more than 80,000 customers, offices in more than 30 countries, and one of the strongest sales forces in the industry. Its breadth of products enables the company to cross-sell chips and achieves gigantic economies of scale -- definitely one of its main competitive advantages. Another significant advantage the company has over other semiconductor firms is that it's not dependent on just one market for its success. Take a quick look at this chart to see just how many end markets TI participates in:

TI's chips are in everything from microwaves to automobiles to surgical robots, so it's not overly dependent on just one catalyst or trend to help it achieve top-line growth. In fact, TI is currently going through a massive transition, moving away from its traditional baseband chips -- those that help cell phones connect to a network -- which were lower margin and heavily concentrated on one particular customer (Nokia (NYSE: NOK)), and more toward analog and embedded chips, which is a space with much better growth opportunities.

Why so cheap?
For a company that pays a 2% dividend, has over $2 billion in cash, zero debt, and a dynamite balance sheet, TI trades for a ridiculously low P/E multiple of 12.4. Not only is this much lower than the industry average, but it's also lower than TI's normalized five-year average.

I think the main reason that some investors have turned their back on TI is the uncertainty that surrounds its move away from the baseband chip market. For sure, this shift in business strategy can't be overlooked -- in 2009 the segment produced $1.7 billion in revenue, or 17% of total sales. There's no denying it, that's a lot of cash to forgo, and in an extremely quick time period: TI expects total baseband revenues to completely vanish by the end of 2012.

So what's going to replace what was once a very fruitful and profitable business segment?

Analog chips for sure -- the need for power management and energy efficiency will only increase as mobile devices become more and more prevalent. In addition, embedded applications like microcontrollers (which perform mathematical computations almost instantaneously) are needed in almost any electronic product one can imagine. It's a $10 billion-plus market, and TI estimates it has 11% market share, which, in a fragmented market, is most likely a leading position. During the second quarter of 2010, analog sales increased 56% annually while embedded chips saw a 47% increase. It's not going to be easy for such a behemoth to stop dead in its tracks, eliminate an enormous business line, and then surge forward in a different direction, but so far, TI seems to be on the path to success. Check out the last few quarters of segment growth:

As you can see, TI's baseband revenue is slowly winding down, while analog and embedded sales have seen a really nice uptick since the second quarter of 2009. Operating profits for both segments increased in the latest quarter, which ultimately helped TI achieve its highest ever quarterly operating profit, pretty impressive for a company that's been around for more than 70 years.

The buy opportunity
While the market has edged up in 2010, TI has seen its share price trail the market and it's still in the red. This presents value-seeking investors with a great opportunity to get in on a marketing-leading blue chip for a dirt cheap price.

Currently priced slightly below $26, I believe the market is assuming about 1%-2% growth over the next five years and barely much more thereafter. This, of course, I consider to be a ludicrous assumption. Reflect on the various catalysts for growth -- smartphones, medical devices, energy-efficient automobiles -- and then remember that we're talking about the No. 2 chip maker in the U.S. with an industry-leading sales force. I find it hard to imagine permanently sluggish growth. In fact, when I assume relatively modest 3% growth over the long run, I obtain a fair value estimate just north of $28. When I run a more realistic scenario of growth between 3% and 7%, the share price settles in nicely at about $32, providing investors with a 25% margin of safety.

With relatively limited downside, a history of operational success, seasoned management, and a nice 2% dividend kicker, getting in on TI now is better than a bargain -- it's a steal.

Previous 11 O'Clock Stock recommendations:

• Molson Coors Brewing
• Johnson & Johnson
• Apple
• Landstar
• CGG Veritas
• Track the performance of our full list of recommendations

Interested in reading more about Texas Instruments? Add it to My Watchlist, which will find all of our Foolish analysis on this stock.

Come back to Fool.com tomorrow for another great stock pick. There's plenty more great stock advice, and you can find video of each day's recommendation as well! To see the performance of previous recommendations, click here.

The Motley Fool will wait at least 24 hours after this publication before buying shares of Texas Instruments. To see an FAQ on the "11 O'Clock Stock," click here.