One Thing Texas Instruments, Inc. Does Right

While not as sexy as a disruptive technology or a hot new product, skillful capital allocation is among the most important strengths a company can have in building long-term shareholder value. It's the subject of William Thorndike's book on outstanding CEOs, The Outsiders, and also that of Warren Buffett's 1987 shareholder letter:

One company with a management team that understands the importance of capital allocation is Texas Instruments (NASDAQ: TXN). In a rare act for public companies, Texas Instruments lays out its capital allocation strategy in a 40-slide presentation on its Investor Relations page. That transparency and discipline could be why the company has lasted 87 years, including more than six decades in the fast-changing semiconductor industry, with a 2.44% dividend that has grown 15-fold over the past decade. Here are all the ways Texas Instruments management does capital allocation right.

Holding themselves accountable

Slide six of the presentation provides a snapshot of how $73 billion worth of capital has been deployed over the past 10 years across research and development, sales, capital expenditures, share repurchases, dividends, and acquisitions. At the end of the presentation, the company grades itself across 10 capital allocation criteria for each of the past four years. Because of its commitment to providing and regularly updating the presentation, management knows every dollar it spends today will be tallied and scrutinized by shareholders 10 years from now.

The right metric

Many companies focus on revenue growth, earnings, or rising dividends; however, Texas Instruments focuses on the metric that leads directly to shareholder value: free cash flow per share.

Turning once again to Buffett, this time in 2000: "Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business."

As a result of this focus, Texas Instruments has increased free cash flow per share at a 12% average growth rate since 2004, with a 9% increase in 2016. In the same year, the company's free cash flow margin increased 90 basis points to 30.5%, above the company's target range of 20% to 30%, putting it in the 88th percentile of the S&P 500 in that category.

Always prepared

Despite healthy shareholder returns, the company also commits to always having enough cash on hand to meet its dividend payments and debt obligations over the next 12 months. Texas Instruments also has a fully funded pension, which is somewhat unique at a time when many companies (and municipalities) have sizable unfunded pension obligations.

By being conservative with its cash on hand, the company is able to have access to low-cost debt. In 2016, the weighted average interest rate on the company's debt was only 2.22%.

Disciplined buying

The history of corporate acquisitions is not inspiring. According to a 2015 Harvard Business Review research report, between 70% and 90% of all acquisitions fail.

That is why it's heartening to see Texas Instruments present strict criteria for making acquisitions. Acquisitions must either leverage or deepen its strengths in analog chips, and returns on capital must exceed the cost of capital within three to four years.

Likewise, the company's repurchase policy is to buy back shares only when the stock price is below intrinsic value, based on reasonable growth assumptions. While this approach may seem obvious, history has shown some CEOs often repurchase shares when times are good and stock prices are high. By being prudent with repurchases, Texas Instruments has reduced shares outstanding by 42% over the past 12 years while retaining a conservative cash profile.

Long-term focus

Texas Instruments makes sure it's set up for the future. In fact, the company has a policy that allows the purchase of used manufacturing capacity when available on the market at heavily discounted prices, so it always has growth capacity three to five years in advance. That may decrease utilization and expend capital in the near term, but will increase cash flow in the long term. That long-term orientation is how the company has remained relevant in the chip industry for decades.

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Billy Duberstein has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.