In the technology space, stocks like Apple and Facebook get most of the attention. One company that doesn't get nearly as much attention is Texas Instruments (TXN 1.27%). Texas Instruments is a relatively under-followed company in comparison to the megacaps in the tech space, but that's not because the company is unworthy. Far from it. In fact, Texas Instruments has grown revenue and earnings per share at solid rates since the Great Recession, and it has rewarded shareholders with billions in stock buybacks and rising dividends each year.
Texas Instruments may not be the sexiest company, nor does it have the flashiest business model, but investors should take notice of this stock for its industry leadership position, high free cash flow, and excellent cash returns.
Structural shift pays dividends
Texas Instruments' core strategic objective over the past several years was to divest under-performing areas of the company, such as its legacy wireless business, to instead focus on its core competencies. Texas Instruments is now out of the wireless business and has shifted into higher-value businesses like analog and embedded processing.
At the same time, Texas Instruments also changed its capital expenditure policy. The company opportunistically purchased manufacturing assets on the cheap. Its remaining core businesses feature high-value assets and products with long life cycles.
After its restructuring, Texas Instruments operates a very streamlined, focused business. It derives approximately 85% of its total revenue from its two core industries, analog and embedded processing. According to the company, Texas Instruments generated 9% compound annual revenue growth in analog and embedded processing from 2009-2014.
These two areas have continued to perform well, which has helped offset some weakness in Texas Instruments' other areas. Last quarter, its total revenue fell 2% year over year due to weak demand for communications equipment. But revenue in analog processing grew for the eighth straight quarter on a year-over-year basis, which helped keep revenue intact. And, thanks to the manufacturing asset purchases mentioned above, Texas Instruments expanded its gross margin by 1% year over year, to 58.2%.
Excellent free cash flow
Such steady growth allows Texas Instruments to generate high levels of free cash flow. In the trailing four quarters, free cash flow as a percentage of revenue reached 27%, a two-percentage-point increase over the year-ago period. Overall, free cash flow in the last four quarters grew 13%, to $3.6 billion.
This free cash flow is piling up on the balance sheet. At the end of last quarter, Texas Instruments held $3.3 billion in cash and short-term investments, which amounts to 6.5% of the company's market capitalization. And, unlike many other technology giants, most of Texas Instruments' cash -- approximately 82% -- is held by its U.S.-based entities. This means the company can access its cash to reward shareholders with rising dividends and share buybacks. The dividend makes up just 38% of total free cash flow, and Texas Instruments has done an excellent job of reducing its share count over the past decade.
TXN Average Diluted Shares Outstanding (Annual) data by YCharts.
Potential for high dividend growth
Thanks to its strong free cash flow and low payout ratio, there is plenty of potential for Texas Instruments to continue growing dividends at a rapid pace. It has raised its dividend for 11 years in a row and has paid dividends to shareholders uninterrupted since it first began making dividend payments in 1962. Last quarter, Texas Instruments bought back $2.6 billion of its own stock.
Based on its 2.7% dividend yield and price-to-earnings multiple of 17, Texas Instruments appears to be an undervalued stock with a strong dividend yield and stock buybacks. For these reasons, investors looking for a strong dividend stock with high free cash flow in the technology sector should consider Texas Instruments.
