Which of These Chip Makers Is the Best Buy?

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Semiconductor juggernaut Texas Instruments (NASDAQ: TXN) handed in a second-quarter earnings report that contained good news across the board, and its shareholders were rewarded with a strong 4% gain on the day of the announcement.

In what has been an otherwise difficult and often disappointing year for large-cap technology stocks, Texas Instruments bucked the trend. At the same time, the company’s strong performance is likely priced in, thanks to an above-average valuation among technology stocks. What’s an investor to do in the wake of Texas Instruments’ impressive quarter?

A win-win-win for shareholders

Texas Instruments did very well for its owners in the most recent quarter on three counts. The combination of cost cuts and increased demand for its chips were major factors behind the company’s 48% jump in second-quarter profits.

Moreover, the company handed in a strong forecast for current quarter revenue that exceeded most analyst expectations, thanks to its customers feeling much more confident about placing orders for chips.

Management was quick to point investors to the turnaround in customer attitudes in the first half of 2013 as opposed to last year. Whereas 2012 represented an extremely challenging year for Texas Instruments due to broad global economic uncertainty, the company noted its customers are more upbeat through the first half of this year.

A shift in focus

Texas Instruments is streamlining its operations, in an attempt to focus its efforts on its best-performing segments. The company is winding down its wireless chip business due to intense competition from Qualcomm Incorporated (NASDAQ: QCOM).

Instead, Texas Instruments is focusing on analog and embedded chips, which are used in products such as cars and televisions. Analog and embedded chips already account for most of the company’s revenue (78% to be exact, up 6 percentage points year over year), and those areas will be the focus going forward.

This can be a win for both Texas Instruments and Qualcomm. Each company will be able to do what it does best and dominate its respective areas going forward.

Qualcomm's smartphone dominance was on full display when it reported fiscal third quarter results, in which it saw earnings per share soar 30% on the strength of 35% growth in revenue year over year.

Of course, no discussion of large-cap semiconductors is complete without mentioning Intel (NASDAQ: INTC), which has had its share of difficulties in recent periods. Intel disappointed its investors when it released its own quarterly earnings report. Revenue and diluted earnings per share fell 3% and 25%, respectively. Revenue is still struggling due to softening PC sales worldwide, and higher R&D expenses due to the company’s feverish push into mobile devices are dragging down profits. It remains to be seen whether or not Intel’s long-desired penetration into mobile will pan out.

For now, however, investors can take solace in the company’s generous dividend, which stands at nearly 4% at recent prices and should only grow in the near future. Intel is due for an annual dividend increase, and should announce a dividend bump over the next couple weeks. Despite its struggles, Intel’s investors are being paid well to wait for the company’s turnaround efforts to materialize.

Valuation a cause for concern

Despite Texas Instruments’ solid quarter and upbeat outlook, there’s no escaping the fact that this is one of the more richly valued stocks among large-cap technology.

Texas Instruments trades for 24 times trailing earnings. Qualcomm is more attractively valued at 17 times EPS, which is roughly on par with the S&P 500 Index’s valuation. Intel, meanwhile, is even less expensive, exchanging hands for just 12 times earnings.

Like Intel, Texas Instruments and Qualcomm pay solid dividends to shareholders, albeit not close to Intel’s 4% yield. Texas Instruments and Qualcomm yield 2.8% and 2.2%, respectively, which are still strong payouts in an era of extremely low interest rates.

Texas Instruments is a high-quality company, but at its current level, I’d recommend investors give Qualcomm and Intel preference based on their more reasonable valuations. Texas Instruments is a great company that I would like to own, but I can’t bring myself to pay 24 times EPS. On a significant pullback, of 15% to 20%, Texas Instruments would be a screaming buy, and I’d recommend Foolish investors wait for better prices before jumping in.

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Robert Ciura owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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