In the technology sector, most investors on the hunt for dividends typically flock to industry giants such as Intel, Microsoft or IBM, which is one of Warren E. Buffett's favorite dividend stocks.
But there is a hidden dividend gem in the sector.
The company, with its blue-chip dividend stock, was founded in 1951 and has increased its dividend payments every year since 2003.
Due to a change in strategy several years ago, Texas Instruments has generated strong growth in cash flow and dividends for many years.
Texas Instruments stock has returned 28% year to date and 40% in the past year, not including dividends. It has resoundingly beaten the S&P 500 during that time, and the gains may be just getting started.
The company used to be more diversified, spread out across a wide range of different businesses, but it soon realized that it had become bloated and was ceding ground to more nimble competitors. Flexibility is critical in the tech industry.
In response, the company divested several businesses that weren't growing much such as its legacy wireless segment. It focused investment on two key areas, analog and embedded processing, which now make up more than three-quarters of total company sales.
Analog processing involves the company's high-volume analog and logic business, as well as power management. Embedded processing involves the company's product lines in connectivity, microcontrollers and processors.
The change in focus has allowed the company to focus on the industries that it thinks have the highest growth opportunities, such as automotive, industrial and communications equipment.
The strategy has worked wonders.
Since 2004, free cash flow has risen by 7% annually With such strong cash flow, Texas Instruments has handsomely rewarded investors with share buybacks and dividends.
The share count is down 40% since 2004, and Texas Instruments raised its dividend 12% last year.
This year has been a strong one for Texas Instruments.
Operating cash flow is up 9% in the past 12 months, versus the previous trailing 12-month period. Embedded processing was the strongest-performing segment for the company in the second quarter, posting a 9% revenue increase from a year earlier.
The company-wide gross margin clocked in at 61% in the second quarter. Gross profit margin expanded by 300 basis points during the quarter, primarily due to declining manufacturing costs.
Texas Instruments is able to generate high profit margins and keep manufacturing costs low partly because its new operating strategy is to acquire manufacturing assets as cheaply as possible.
Through the second quarter, free cash flow margin as a percentage of sales was up 260 basis points, to 30%. Texas Instruments keeps a stated policy of returning 100% of free cash flow to investors through direct cash returns.
Going forward, Texas Instruments should be a top dividend growth stock. Not only does the company generate huge levels of free cash flow, but it also has $2.5 billion in cash and marketable securities on its balance sheet, 80% of which is held in the U.S.
Having that cash in the U.S. means that it can be used for dividend increases. For the most part, tech companies with the largest cash balances have that cash overseas, which means it can't be used without incurring a significant repatriation tax.
It has been a full year since Texas Instruments increased its dividend. The company typically increases its shareholder payout in September.
Because Texas Instruments has the vast majority of its cash in the U.S., a low payout ratio and a long runway of growth ahead, it is likely that the company will pass along another double-digit increase very soon.
Texas Instruments has had an incredible run over the past year, but it has generated enough growth to justify such a strong rally in share price.
The stock trades for a reasonable forward price-earnings ratio of 22.83, and the stock has a 2.2% dividend yield, which is a bit above the average dividend yield of the S&P 500.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.