Fundamental strength alone isn’t enough to make TXN a good buy right now

October 25, 2018

Fundamental strength alone isn’t enough to make TXN a good buy right now

The last couple of weeks have seen market volatility return in a big way, and with it fear seems to be increasing quite a bit this week. I think part of it is because investors are starting to realize how close the market is right now to an important inflection point. As of yesterday’s close, the tech-dominated NASDAQ had officially dropped more than 10% below its last all-time high, which was reached back in late August. To add insult to injury, both the Dow and the S7P 500 have given back almost all of the gains they’ve achieved since the last correction that ended in March of this year, and are now slightly lower for the entire year.

Is it time to start waving the flag and say that the longest bull market in recorded history is finally over? I’m not so sure about that; bear markets really tend to be the product of economic recessions, and while there is rising concern about the current economy’s upward sustainability, a downturn is anything but a given right now. I saw a report this week indiTXNing that of the 140 or so stocks that had reported earnings so far this quarter, more than 80% beat earnings estimates. Since 1994, the average percentage of companies beating estimates in any quarter is 64%, which means that despite concerns about global economic strength amid tariffs and trade tensions, rising interest rates, Brexit, and so on, corporate profitability remains healthy. And while President Trump may rail against the Fed’s current policy of interest rate increases – to be clear, he seems to be opposed to any kind of rate increase – the truth is that the greater concern could be that the Fed is moving too slow and has put themselves behind the curve if and when the time does come to stimulate the economy rather than trying to moderate or restrict it.



The smart thing right now, for any investor, no matter what your investing philosophy might be, is really to step back for a bit, take a deep breath, and give yourself some time to reevaluate what’s going on right now. Increasing fear means that the risk the market could give itself over to outright capitulation – where even the most hardened bull finally starts selling – is also increasing. Capitulation is a big word for a lot of bearish market conditions, including the kind of panic selling that can and often does turn a simple correction – which is where the NASDAQ is right now, and where the Dow and S&P 500 could be soon – into an outright bear market. I’m not waving the white flag on the market just yet, because I think there are still some solid fundamentals that point to the idea the market could still extend itself even further for the next couple of years. We are very close to an emotional turning point, however, and it is foolish to ignore the reality that market is, and always has been an emotional animal.

We’re in an interesting conundrum right now, because with the broad market market down nearly 10%, and the retreat even extending to small-cap stocks (the Russell 2000 is down a little over 15% since its last all-time high in August), the truth is that there are a lot of stocks that are trading right now at major discounts versus their own recent highs. Texas Instruments Inc. (TXN) is a very good example of what I mean. This week has really been brutal for the stock; after its earnings report on Tuesday beat expectations, but included scary words like industry slowdown in its view of slowing growth ahead, the market pushed the stock down more than 8% in a single session. That one-day drop pushed the stock into its own bear market territory, since it is now down a little over 20% since its last significant pivot high in late August, and about 24% since its all-time high was reached in January of this year.

As a value-oriented investor, I’m just enough of a contrarian that even in the midst of what could be a looming sea change in the broad market, the kind of downturn in a stock like TXN is something that makes me sit up and take notice. This is one of the titans of the semiconductor industry, and a company that sports an incredibly impressive fundamental profile. Semiconductors is an industry that has been, and remains under a lot of pressure from trade pressures, particularly as it relates to China; but I find it interesting that while a lot of well-known names in this industry are starting to include tariffs in their earnings discussions, TXN is not; in fact, they don’t seem to be overly concerned about tariffs at all, since more than 60% of their total revenues every year come from long-term supply contracts with its biggest customers. The stock mostly seems to be the victim of the industrywide downturn and concern that the several years of rapid growth throughout the industry have finally reached their apex. I think that means there remains a fair amount of risk in this sector right now; I also think that TXN’s stock remains significantly overvalued despite its downturn for the year. So let’s dive in and see where I think this stock needs to be to turn its fundamental strength into a can’t-miss value opportunity.



Fundamental and Value Profile

Texas Instruments Incorporated designs, makes and sells semiconductors to electronics designers and manufacturers across the world. The Company operates through two segments: Analog and Embedded Processing. As of December 31, 2016, the Company had design, manufacturing or sales operations in more than 30 countries. The Company’s Analog segment’s product line includes High Volume Analog & Logic (HVAL), Power Management (Power), High Performance Analog (HPA) and Silicon Valley Analog (SVA). HVAL products support appliTXNions, such as automotive safety devices, touchscreen controllers, low-voltage motor drivers and integrated motor controllers. The Company’s Embedded Processing segment’s product line includes Processor, Microcontrollers and Connectivity. Processor products include digital signal processors (DSPs) and appliTXNions processors. DSPs perform mathematical computations to process digital data. TXN’s current market cap is $89.5 billion.

  • Earnings and Sales Growth: Earnings and sales growth is very strong; over the last twelve months, TXN’s earnings grew 33%, while revenues increased a little less than 9%. In the last quarter, earnings growth was more than 13%, while sales growth was just a little over 6%. Growing earnings faster than sales isn’t easy to do, and generally isn’t sustainable in the long-term; however it is also a positive mark of management’s ability to maximize its business operations. The company also operates with a very impressive margin profile, since Net Income over the last twelve months as of the end of the third quarter was almost 30%, and actually increased in the third quarter to nearly 37%.
  • Free Cash Flow: TXN’s free cash flow is very healthy, at more than $5.7 billion for the last twelve months as of the third quarter of the year. This number has also increased steadily since the last quarter of 2013, which is a reflection of industrywide growth over the period. If TXN’s CEO is correct, and the industry is about start slowing down, this number could decline in upcoming quarters.
  • Debt to Equity: TXN has a debt/equity ratio of .48. This number is generally low, and reflects a conservative management philosophy about its use of leverage. The company also has excellent liquidity, with more than $5.1 billion in cash and liquid assets against about $4.3 billion in long-term debt.
  • Dividend: TXN pays an annual dividend of $3.08 per share, which translates to a yield of 3.34% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for TXN is $10.94 per share and translates to a Price/Book ratio of 8.41 at the stock’s current price. This is where the cracks start to show up in the argument for thinking about the stock as a bargain right now; the stock’s historical Price/Book ratio is only 6.32, suggesting that stock is almost 25% overvalued right now. That means that the baseline “fair value” for the stock is really around $69 per share. That’s not the bargain price, mind you – that’s just the price that most value-oriented investors would concede represents a fair value for the stock under normal market conditions. The stock hasn’t been that low since late 2016.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The chart above outlines the stock’s movement over the past year. Its downward trend is easiest to discern using its early June high down to its current level, but it’s easy to see here how volatile this stock has been. The stock dropped yesterday below its late 2017 levels to establish a new 52-week low, and given the speed and depth of the drop in just the last month, it isn’t unreasonable to suggest the stock could easily drop to around $83, nearly to its highest price levels through most of 2017 in short order.
  • Near-term Keys: Fundamentals notwithstanding, there is little to justify any kind of a bullish forecast in TXN right now. If you are willing to be extremely speculative, you can try to play the “fill the gap” trading strategy, but even that carries pretty limited upside right now versus downside risk. The only smart, high-probability trading strategy with this stock right now is on the bearish side, either by shorting the stock or by buying put options with a target price in the $83 to $84 range. I mentioned earlier that the stock’s “fair” value is around $69, suggesting downside risk is even more elevated right now; that begs the natural question any value investor should be asking, which is where a “nice” price actually sits for this stock. I like to work with a Price/Book value that is around 20% below the stock’s historical levels, which means that TXN would have to drop below $60, and into the mid-$50 range before I would be willing to start taking the stock seriously as a legitimate value play.