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Better Buy: NVIDIA vs. Texas Instruments

John Ballard, The Motley Fool

The processor chip industry is currently going through a slowdown, which means if you're a shareholder of NVIDIA (NASDAQ: NVDA) or Texas Instruments (NASDAQ: TXN), you're wondering if you made a mistake. But if you're not a shareholder, you're wondering if there's potential to scoop up a bargain and take advantage of the recent downturn. The perception of value can depend on your frame of reference.

History is certainly on the side of the latter, since the best time to invest in chip companies (or any company) is during times of low demand and, therefore, low expectations for growth. That scenario typically gives investors the chance to buy high-quality companies at discounted prices -- a recipe that builds wealth through stocks over the long term.

NVIDIA and Texas Instruments have been through these down cycles before. In the past, these companies took their hits, got stronger, and returned with a vengeance when demand picked up again.

Both companies have reported uninspiring operating results lately, but that won't last forever. NVIDIA and TI are providing processors for a wide range of applications, particularly within the transportation sector, as cars are becoming more computerized.

We'll compare both stocks on financial fortitude, valuation, capital returns, and competitive advantage to determine which is the better buy for investors today.

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Image source: Getty Images.

Financial fortitude

It's always beneficial to invest in companies that can withstand the inevitable downturns in the economy (especially in the chip industry), which is known for its cyclicality. Here's how NVIDIA and Texas Instruments stack up on key financial metrics: 

Metric NVIDIA Texas Instruments
Cash $7.59 billion $4.23 billion
Debt $1.99 billion $5.07 billion
Revenue (TTM) $12.42 billion $15.78 billion
Free cash flow (TTM) $3.39 billion $6.06 billion

Data source: YCharts. TTM = trailing 12 months.

Revenue and free cash flow are provided to give you a sense of these companies' relative size. The two metrics we're interested in are cash and debt. NVIDIA has more cash on its balance sheet compared to Texas Instruments, even though the graphics card specialist generates less revenue. NVIDIA also has less debt, which makes it the obvious winner.

Winner: NVIDIA

Valuation and dividends

No evaluation can be complete without a review of how both stocks stack up on valuation and capital returns. Here's how they compare on a range of popular valuation metrics: 

Metric NVIDIA  Texas Instruments
Trailing P/E 19.24 17.91
Forward P/E 24.17 18.96
PEG ratio 1.47 2.52
Price-to-free-cash-flow ratio 26.61 16.40
Dividend yield 0.42% 2.77%
Cash payout as a percentage of free cash flow 10.74% 42.18%

Data sources: YCharts and Yahoo! Finance.

NVIDIA trades at a forward P/E ratio of 24, which is more expensive than TI's forward P/E of 19. TI stock is also less expensive on a price-to-free-cash-flow basis.

However, NVIDIA has historically grown faster than TI and that's expected to continue over the next five years. Analysts expect NVIDIA to grow earnings 15% per year over the next five years, whereas analysts expect TI to increase profits 8% per year. As a result of higher growth expectations, NVIDIA has a lower PEG (price-to-earnings-growth) ratio.

All in all, I think both stocks are even on valuation. So what about capital returns?

Because of NVIDIA's massive growth opportunities across data center and self-driving cars, the company is prioritizing investing for growth over dividends. NVIDIA distributed 35% of free cash flow to shareholders through dividends and share repurchases over the last year, which is much lower than Texas Instruments. 

On the other side, TI's products, including analog and embedded processors, are not as capital-intensive as NVIDIA's DRIVE PX car computer for autonomous vehicles, so TI doesn't have to spend as much on research and development (R&D) to drive growth. Because of TI's capital efficiency, management is committed to distributing 100% of annual free cash flow to shareholders in the form of dividends and share repurchases. 

The stocks tie on valuation, but TI has better capital returns.

Winner: Texas Instruments

Competitive moat

NVIDIA is a top candidate for most-hated stock in the market over the last four months. The company enjoyed tremendous momentum in the first half of 2018, but fortunes turned on a dime when the cryptocurrency market collapsed, which caused an overhang in the supply of graphics cards. The situation in the short term has worsened due to the economic slowdown in China, which caused NVIDIA to recently revise its guidance down for the fiscal fourth quarter ending in January. 

Texas Instruments has suffered from lower demand in China as well. However, because TI's business is spread across many markets, such as personal electronics, communications equipment, enterprise systems, industrial, and automotive, the company has weathered the recent turbulence in chip demand better than NVIDIA.

Based on management's guidance, NVIDIA's fourth-quarter revenue is expected to be down about 25% year over year. Meanwhile, TI released its fourth-quarter results on Jan. 23, and the company reported that revenue was down only 1% year over year. Analysts expect NVIDIA's adjusted earnings per share to be down about 21% year over year for the fiscal fourth quarter. On the other side, TI managed to report growth in adjusted earnings per share of 16.5% year over year. 

As long-term investors, we don't want to be in the habit of deciding which stock to buy based on which is performing better in the short term. We're more interested in where a company will be in 10 years and beyond. But the recent performance between the two companies during a slowdown in the chip industry highlights TI's relative strength and competitive advantage.

TI has spent decades investing in its manufacturing process to lower costs and deliver products on time and at competitive prices to customers. The company has been through several up and down cycles in the chip industry since it began operations during the Great Depression in 1930. 

NVIDIA may grow faster than TI over the long term, but with the uncertainty over trade tensions with China and their short-term impact on the economy, I would instead put my money into a chip stock that has a durable competitive advantage that has been tested for decades. So, I give the edge to TI on this one.

Winner: Texas Instruments

Texas Instruments is the better buy

I believe both stocks are good long-term investments, and I own shares of NVIDIA. But Texas Instruments is the better stock to buy at current market prices.

TI has an appealing capital return policy. Most importantly, the company is very profitable and is benefiting from the increasing use of processors in a range of industrial and automotive applications. Texas Instruments is one to buy and hang on to for the long haul.

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John Ballard owns shares of Nvidia. The Motley Fool owns shares of and recommends Nvidia. The Motley Fool owns shares of Texas Instruments. The Motley Fool has a disclosure policy.