1 Semiconductor Stock for the Summer
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The NASDAQ Composite just recorded its best first quarter since 1991! So the 4% given back in April thus far seems rather muted. Investors shouldn’t feel that they have missed the boat. In fact, the technology sector offers great value and in a series of posts I intend to highlight potential names that could help position portfolios for market-beating returns. I have written numerous times regarding my favorable view of Microsoft (NASDAQ: MSFT). They world’s largest software company just had a solid quarterly release with a positive stock reaction. My previous blog highlighted Intel’s favorable attributes and in this article I highlight another stock that looks poised to break out to a new five-year high.
Texas Instruments (NASDAQ:TXN) has frequently disappointed investors and is a classic example of how difficult it can be to consistently make money selling products in the absence of pricing power and cut-throat competition. The company remains prevalent in today’s marketplace, but the stock continues to languish. It currently resides at $32, a notable improvement from the recession low, but still falls short of the 2007 high of $40 and its all-time high of $93 reached in 2000. After more than 12 years in a bear market, TXN stock may be poised to leap past $40 per share and up toward $50 in quick order.
Favorable to Texas Instruments is that fact that businesses might finally be starting to increase demand for communication gear following a pronounced and persistent downturn due to the onset of the global financial crisis. This segment is the company’s largest at 40% of total sales. The latest durable goods report showed that communication equipment new orders surged 11% in February! Telecommunication capital expenditures as a ratio of sales has shown a consistent decline since the collapse of the Tech Bubble. Not only has this factor weighed on results, but communication equipment as a percentage of total technology investment has declined notably since 2006. The bottom-line is that there is plenty of pent-up demand and companies with a presence in communication-related products have an opportunity to produce better than expected results in the coming quarters.
Turning the corner?
Texas Instruments is the world’s largest analog chipmaker, but they also have a presence in embedded chips as well as wireless chip technologies. The company reported first quarter 2012 results on Monday that was subpar, but management made it clear that they felt a bottom was in place. Sales were down 8% year-over-year and net income was down 60%. Part of this reflects the company’s decision to exit from chips used in older cell phone designs from Nokia. The company is also integrating its $6.5 billion acquisition of National Semiconductor that was completed last year. Offsetting weak results was order growth of 13% and an improved backlog.
Initially, the price-to-earnings ratio of 17x doesn’t scream cheap, but this is a result of the year-over-year decline in earnings. The price-to-sales ratio stands at 2.8x, one of the lowest in a decade. The price-to-book at 3.5x in not overly compelling either, but does reside at roughly the mid-point of the ten-year average. So while the traditional fundamental analysis really doesn’t jump off the page, there are other compelling aspects that should appeal to investors.
First, the company pays a 2% dividend and has grown this ratio substantially in recent years. The five-year average growth rate of dividends is more than 30% and there is plenty of room for this to continue with a payout ratio of just 29%. The free cash flow yield (operating cash flow divided by enterprise value) is in value territory at 6.2%. Investors should note that free cash flow growth has been muted of late and bears monitoring. It is unlikely that shares outperform the market for a prolonged period without consistent growth in free cash flow. Internal return metrics are incredibly strong for a semiconductor company. Return on invested capital has exceeded 20% in each of the last six years! This number often gets little attention, but the stock will move higher should return on invested capital continue to substantially outpace the firm’s weighted average cost of capital. And lastly, the stock isn’t loved by Wall Street with more Holds and Sells than Buys. Should the macro environment provide the impetus for quarterly beats, there is plenty of room for analyst upgrades and positive media grabbing headlines.
Qualcomm (NASDAQ: QCOM) recently moved to new highs and could be a precursor to what TXN shares are capable of in coming quarters. Qualcomm is similar in size to Texas Instruments and is the innovator of key communication standards in wireless technology and the holder of many intellectual property rights. The fundamentals on Qualcomm stock are not much different than TXN with a slightly higher price-to-earnings ratio at 18x, a slightly better FCF yield at 7%, and lower dividend yield and growth rate, and worse ROIC numbers. Qualcomm is also positioned to benefit from expansion in communication equipment outlays and merits attention as a possible investment following the recent 10% pullback in the shares.
Texas Instruments has caused investors heartache for the better part of 12 years. There isn’t a lot of love for this consistent underperformer, but now just may be the time to invest in the stock. Macro fundamentals are turning from overly bearish to incrementally positive and just may send the shares soaring in the next year or two, especially if the investing community jumps on the bandwagon. The stock doesn’t have as much appeal as a core holding to the super-cheap, bellwether technology names such as Microsoft, Intel, Cisco, and others. Still, the stock could potentially beat them all in the next 12-24 months, especially in the context of a rising equity market.
market8 owns shares in Microsoft. The Motley Fool owns shares of Microsoft, and Qualcomm. Motley Fool newsletter services recommend Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.