Despite Its High P/E Ratio, Is Texas Instruments Incorporated (NASDAQ:TXN) Still Undervalued?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Texas Instruments Incorporated’s (NASDAQ:TXN) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Texas Instruments has a P/E ratio of 20.39. That means that at current prices, buyers pay $20.39 for every $1 in trailing yearly profits.

View our latest analysis for Texas Instruments

How Do You Calculate Texas Instruments’s P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Texas Instruments:

P/E of 20.39 = $116.37 ÷ $5.71 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

In the last year, Texas Instruments grew EPS like Taylor Swift grew her fan base back in 2010; the 55% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 24% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

Does Texas Instruments Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below Texas Instruments has a P/E ratio that is fairly close for the average for the semiconductor industry, which is 20.4.

NasdaqGS:TXN Price Estimation Relative to Market, April 18th 2019
NasdaqGS:TXN Price Estimation Relative to Market, April 18th 2019

Texas Instruments’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if Texas Instruments actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.

Remember: P/E Ratios Don’t Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Texas Instruments’s Balance Sheet Tell Us?

Net debt totals just 0.8% of Texas Instruments’s market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Bottom Line On Texas Instruments’s P/E Ratio

Texas Instruments’s P/E is 20.4 which is above average (18.2) in the US market. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Texas Instruments. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.