Why You Should Avoid TI, Buy These Riskier Stocks Instead

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One of the most basic principles of financial theory is that riskier assets outperform--and this makes sense. The market originally assigns higher discount rates to uncertain future earnings distributions; but, when the fundamentals deliver, it starts lowering those discount rates to increase shareholder value. In this article, I review why you should buy two beaten down semiconductor companies over a much stabler peer.

Texas Instruments (NASDAQ:TXN): Why Investors Are Sitting on the Sidelines

Texas Instruments, commonly abbreviated "TI," is a supplier of semiconductors and analog devices. It is the third largest semiconductor company, while it leads globally in analog technology. The company has a large market share with quite a strong balance sheet. Its revenue breakdown indicated that it had $6.375 billion from its analog segment, $2.11 billion from its embedded segment, $2.518 billion from the wireless segment and some $2.732 billion from other segments. Total revenue stands at $13.735 billion.

Management also remains committed to returning free cash flow to shareholders, as evidenced by the annual dividend growth rate of 30%. TI has had a cash flow of $7 billion between 2009 and 2011 and has repurchased shares worth $5.4 billion. The share repurchase has resulted in a reduction in the number of shares from 1.77 billion to 1.15 billion. Within the same time frame, TI paid $1.8 billion worth of dividends It is more than sustainable, since the payout ratio stands at just 43.9%.

Despite this shareholder-friendly capital allocation policy, TI does have some pitfalls to watch out for. A good example is the competition that the wireless segment has faced recently. Though the effect was not severely felt because of the good performance in other segments, the wireless segment still faces a challenge. This calls for development of new products and increased research and development. TI’s response to changes in the market has been slow, and this has led to abandoning the production of mobile chips. Combined with the unstable world economy, investors are rightfully sitting on the sidelines.

Seagate Technology (NASDAQ: STX): Risky but Undervalued

Seagate Technology is a leading producer of storage devices such as hard drives. The company has made several acquisitions that have helped it achieve many goals in years past. The most recent among these is the purchase of Lacie, a French-American company that makes enclosures for storage. The transaction is said to have involved $186 million. Upwards of three-quarters of Seagate Technology’s revenue comes from OEM, and the rest comes from retail stores and reselling distributors. 

The company’s board of directors agreed to pay a $0.38 dividend for the 2013 second quarter. Since the initiation of dividends, it has continually increased distributions and is now at 4.3%. Since the payout ratio is still only 0.13, there is a good likelihood that the distribution will continue to increase. In addition to offering generous dividends, Seagate has also been buying back shares and has redeemed 17% of total shares. Reduced competition has enabled the company to maintain high prices for its products. The company’s margins are way higher than those of the industry.

And, at 6.3x forward earnings and a 23.5% free cash flow yield, investors can get in at basement prices. The company is yielding high double-digit to triple-digit return on assets, return on equity, and return on investment. Peer Western Digital (NASDAQ: WDC) has been on a rocky ride, trades at only 6x past earnings, and is up nearly 40% over just the last six months. It has a tremendous 20.8% return on invested capital and has room for expanding profit margins, which stand 660 bps below peers. I encourage buying shares in both Seagate and Western Digital to spread out the risk that one will fall through completely.

TakeoverAnalyst has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital.. 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. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a position in the next 48 hours.

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