Chip stocks have experienced choppy trading action this year, but the PHLX Semiconductor Sector Index has managed to stay above water. It’s returned over 17% year to date and has more than doubled over the last two years.
Prospects for more gains look favorable. World Semiconductor Trade Statistics calls for the chip market to increase by 19.7% in 2021 and by 8.8% in 2022. Chips have become the fundamental building blocks of the global economy, with technologies like Internet of Things (IoT), artificial intelligence (AI), and 5G wireless connectivity becoming more pervasive. Investors can not only ride these trends to decent returns, but there are some very profitable semiconductor companies that have a record of paying regular dividends too.
1. Texas Instruments
The semiconductor industry is highly competitive and can be subject to dips in demand when the global economy turns south. There’s also an ongoing risk with rapid technological change and pricing pressures. It’s for these reasons investors should do well with Texas Instruments.
Texas Instruments has been in business since 1930 and has successfully navigated a wide range of geopolitical and economic obstacles. Most importantly, it possesses structural advantages that allow it to produce healthy amounts of free cash flow and pay dividends. It has 14 manufacturing sites worldwide, tremendous product breadth, and over 100,000 customers that use its embedded and analog chips across a wide variety of products, including mobile phones, enterprise computer systems, and autonomous vehicles.
Texas Instruments invests in its own manufacturing process, which allows it to drive costs down, leading to healthy margins. Even during the supply chain disruptions caused by the pandemic, Texas Instruments generated $5.5 billion in free cash flow on revenue of $14.4 billion.
“[O]ur competitive advantage of internal manufacturing and technology delivers the benefits of lower cost and greater control of our supply chain which really shows through in a market environment like this,” said Investor Relations Vice President Dave Pahl during the Q1 earnings call.
Since 2004, Texas Instruments has increased its dividend by 26% on a compounded annual basis. It paid $3.4 billion in dividends in 2020, which suggests a cash payout ratio of 62% relative to free cash flow, providing the business a cushion to maintain dividend payments in a weak demand environment. At a current dividend yield of 2.1%, investors can buy shares of one of the best chip companies around and get paid an above-average yield.
2. Taiwan Semiconductor
Taiwan Semiconductor Manufacturing (TSMC) has built an incredibly profitable business making chips for other companies, including Advanced Micro Devices, NVIDIA, and Intel. Its the leading chip foundry in the world with 57% market share. In 2020, revenue and earnings per share advanced 25% and 50%, respectively. Rising demand for powerful chips for 5G and artificial intelligence applications should keep TSMC in growth mode.
The stock has climbed 365% over the last five years, which beats Texas Instrument’s return of 199%. While TSMC has been the better growth stock, Texas Instruments might be the safer dividend stock. That’s because TSMC pays out virtually all of its free cash flow in dividends. Over the last four quarters, TSMC’s cash payout ratio was 96%, which doesn’t leave much wiggle room to sustain the dividend if chip demand suddenly dropped off.
Moreover, the sharp rise in TSMC shares has made the stock more expensive, trading at over 30 times forward earnings estimates. That has also brought its dividend yield down to 1.4%, but despite its lower dividend yield and high cash payout ratio, there are a few reasons why TSMC should be a great dividend stock.
First, TSMC has a fortress balance sheet, with $23 billion in cash at the end of the first quarter, which is more than enough to offset its debt.
Another reason investors can be confident in TSMC’s dividend payout is the future demand curve for chip technologies. Last year’s growth wasn’t a fluke. Management’s capital budget for 2021 calls for spending between $25 billion to $28 billion. This higher spending is in preparation to meet the growing demand expected over the next few years for 7-nanometer, 5-nanometer, and eventually 3-nanometer chip nodes. TSMC is guiding for revenue to grow between 10% to 15% annualized through 2025.
Texas Instruments and Taiwan Semiconductor Manufacturing are both as solid as rocks. Choosing winners and losers can be difficult in the semiconductor industry, but Texas Instruments and TSMC have delivered exceptional performance, and should continue rewarding investors with solid returns and steady dividend payments for years to come.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.