Texas Instruments’ (NASDAQ:TXN) Return on Capital suggests Expectations may be too Low

Shares of Texas Instruments ( NASDAQ:TXN ) regained some lost ground on Wednesday after the chipmaker announced strong 4th quarter results. The quarterly numbers were ahead of estimates on the top and bottom line, and guidance for the first quarter was raised.

Fourth quarter highlights:

• Revenue at $4.83 bln up 18.4% YoY and $400 mln ahead of consensus estimates.
• GAAP EPS at $2.27 up 26% YoY and $0.33 ahead of estimates.
• non-GAAP EPS at $2.33 up 25% YoY and $0.37 ahead of estimates.
• First quarter revenue expected to be between $4.5 and $4.9 bln compared to estimates of $4.43 bln.
• First quarter EPS expected to be between $2.01 and $2.29 compared estimates of $2.09.
• Seeing strong demand in the industrial and auto sector.

These results indicate a slowdown from the first half of 2021, but revenue growth remains historically high. The company continues to invest in new capacity which suggests they see continued demand in the future.

Texas Instruments’ valuation and growth forecasts

TXN is trading on a price-to-earnings ratio of 22x, which seems quite low given the company’s performance over the last year. We are in the midst of a market correction, but even when the stock price peaked in October the P/E ratio was only around 25x.

Analyst estimates may explain the modest P/E reading. The analysts covering Texas Instruments are only expecting subdued revenue growth of 5.4% over the next few years, while EPS are expected to grow at just 4.3%. These growth rates are well below the market and semiconductor industry.

Analysts are often concerned with a company’s near term prospects, so to get an idea of a company’s earnings potential over the longer term we can have a look at the return on capital employed (ROCE). 

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Texas Instruments, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.40 = US$8.3b ÷ (US$23b - US$2.4b) (Based on the trailing twelve months to September 2021).

So, Texas Instruments has an ROCE of 40%. That's a fantastic return and not only that, it easily outpaces the average of 15% earned by companies in a similar industry.

Check out our latest analysis for Texas Instruments

Above you can see how the current ROCE for Texas Instruments compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Texas Instruments here for free.

What Does the ROCE Trend For Texas Instruments Tell Us?

The trends we've noticed at Texas Instruments are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 40%. The amount of capital employed has increased too, by 48%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that can lead to continued earnings growth.

Our Take On Texas Instruments' ROCE

We noticed that earnings estimates have been rising consistently over the last 18 months. This suggests that analysts have been underestimating the company’s growth, and may continue to do so. The high ROCE and the fact that Texas Instruments is seeing continued demand for its products, suggest there is potential for the company to continue compounding its earnings in the future. 

While Texas Instruments looks impressive, no company is worth an infinite price. The intrinsic value infographic in our free research report helps visualize whether TXN is currently trading for a fair price.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.