Texas Instruments Inc. (TXN, Financial) designs and manufactures semiconductors and is one of the largest suppliers of analog and Digital Signal Processing (DPS) integrated circuits.The company's plan is to increase differentiation in its business and gain exposure to many end markets and customers. Its focus is the analog chip business, which consequently reduces the wireless segment, which is a lower-margin one.The company's largest competitors include Qualcomm Inc. (QCOM) and STMicroelectronics NV (STM).
Turning our attention to the future direction of the stock, let's take a look at the intrinsic value of this company and try to explain to investors the reasons why it is a good buy or not.
Valuation
In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends, getting the John Burr Williams´s original DDM formula:
Let´s estimate the inputs for modeling:
- Required Rate of Return (r)
The capital asset pricing model (CAPM) estimates the required return on equity using the following formula:Â required return on stockj = risk-free rate + beta of j x equity risk premium
Assumptions:
- Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%
- Beta:β =1.26
- GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]
rTXN = RF + βCAT [GGM ERP]
= 2.67% + 1.26 [11.43%]
= 17.07%
- Dividend growth rate (g)
The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm's debt-to-equity ratio is unchanged and it doesn't issue new equity.
g = b x ROE
b = retention rate
ROE can be estimated using Dupont formula:
Because for most companies, the GGM is unrealistic, let's consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.
Final Comment
When the stock price is lower than the intrinsic value, the stock is said to be undervalued and it makes sense to buy the stock. I would advise fundamental investors to consider adding this stock according to our estimations.
Hedge fund managers have also been active in the company. Gurus like Ray Dalio (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) have invested in it.
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Disclosure: Victor Selva holds no position in any stocks mentioned.
[1] This values where obtain from Blommberg´s CRP function.
