Better Buy: Sierra Wireless vs. Qualcomm

Investors looking for plays on the Internet of Things may have their eyes on both Qualcomm (QCOM +0.61%) and Sierra Wireless (SWIR +0.00%). Sierra makes chips and cloud-based software that connect things like industrial equipment and vehicles to the Internet. The company is small, with a market cap of just $675 million, but it has built a leadership position in the machine-to-machine (M2M) and IoT markets.

Meanwhile, tech juggernaut Qualcomm has a market cap of $77 billion,  sells mobile processors and baseband processors (for connecting devices to cellular networks) and has made a killing from licensing its patents to other tech companies. Additionally, it's in the middle of purchasing NXP Semiconductors (NXPI 0.17%), which makes chips for all sorts of Internet-connected devices, including cars. All of which means that Qualcomm and Sierra may soon have overlapping IoT pursuits.

So which stock is the better buy right now? Let's take a look at each company's financial strength, competitive advantages, and valuation in order find out.

Image source: Getty Images.

Financial Fortitude

First, let's take a look at how well these two companies are doing financially:

Data source: Yahoo Finance, YCharts.

These two companies have such a vast size disparity that it's difficult to compare them financially, so let's focus on the one difference that stands out the most between them: debt.

Qualcomm is sitting on about $21.9 billion in debt right now, is about to spend at least $38 billion for NXP Semiconductors,  and also is facing lawsuits and antitrust investigations over its patent licensing practices. While the company does have a lot of cash on hand to address these issues, they will nonetheless likely add financial strain.

Meanwhile, Sierra Wireless is operating with absolutely no debt. Typically, Qualcomm's massive size compared to Sierra's (operating in billions vs. millions) would be enough to give Qualcomm's shares the edge. But multiple lawsuits have hurt Qualcomm's patent licensing business, which brings in the majority of its profits. It has had to lower licensing fees for many of its customers, which caused revenue in its Qualcomm Technology Licensing (QTL) business to plummet 42% year over year in its fiscal third quarter.

Winner: Sierra Wireless.

Competitive advantage

Sierra Wireless is a key supplier of IoT chips, and has built a list of customers and global sales that's pretty impressive for a company of its size. Those chips earn the company 33% of all the global revenue in the embedded module market. Its technology already connects billions of devices to the Internet, and there's no reason to expect that those numbers won't keep growing.

But while Sierra Wireless is a leader in IoT, it does face some serious competition. Rival CalAmp also sells chips in the M2M market, including for usage-based insurance, industrial equipment tracking, vehicle tracking and recovery, and more. CalAmp connects about 7 million devices  to the Internet -- far fewer than Sierra, but it also has a growing list of 653,000 unique software application subscribers, which is an niche where Sierra is still building its presence.

Additionally, Sierra could eventually face some competition from Qualcomm itself, which could use its purchase of NXP Semiconductors -- currently the largest chipmaker for vehicles -- to further expand its footprint in automotive connectivity services. When NXP adds its strengths to Qualcomm's years of baseband chip prowess, the post-merger company could rapidly take a dominant position in the connected car market.

But Qualcomm faces some serious problems of its own. The company used to have a massive competitive advantage thanks to its 3G and 4G patents, but that advantage is quickly eroding. As I mentioned earlier, its patent licensing revenue is falling, and will likely continue to as the company works its way through its pending litigation.

Additionally, while Qualcomm is still a major supplier of mobile processors, some tech companies have begun designing chips for their own devices, and cutting out or cutting down chip orders from Qualcomm. The company made $4 billion in chip sales in the third quarter, up a modest 5% year over year, but its dominance in this space is slipping, and investors can't rely on its processors to be the go-to chips they once were.

Qualcomm may be able to diversify its revenue better after its acquisition of NXP Semiconductors goes through (it's expected to close at the end of this year), but the deal hasn't been finalized. If it ends up falling through, Qualcomm could lose out on new IoT opportunities. All of this uncertainty surrounding Qualcomm's current and potential business makes me question if the company has concrete, long-term competitive advantages, so I'm giving Sierra Wireless the win in this category. 

Winner: Sierra Wireless.

Valuation

Finally, let's take a look at a few key metrics for each company and how they stack up against each other -- specifically, the price-to-earnings (P/E) and forward P/E ratios. The P/E ratio will tell us how much investors are willing to spend for every dollar of company earnings, while the forward P/E is an indicator of what investors will spend per share based on anticipated future earnings.

Data source: Yahoo Finance. 

Qualcomm's current P/E ratio of 17.3 is much lower than Sierra Wireless' 47.4. That technically makes Qualcomm's stock cheaper than Sierra Wireless' (when compared to both the trailing 12-month P/E and forward P/E). Qualcomm's valuation on that measure is also cheaper than the technology industry average as a whole, which has a P/E of about 26.

It's worth pointing out that Sierra's forward P/E (based on on expected earnings) brings the company's valuation closer to Qualcomm's, but I'm giving Qualcomm the win here since it's still cheaper overall. The caveat is that investors should remember that the P/E ratio is just one metric, and shouldn't be given excessive weight in any stock-buying decision.

Winner: Qualcomm.

The verdict

Sierra took two out of three categories in this matchup, and I think that it looks like the better buy at the moment considering that Qualcomm presents investors with so many unknowns. Qualcomm still makes most of its profits from patent licensing, but that's changing, and the company's investing thesis is changing along with it.

Qualcomm may still have a leadership position in the mobile technology space, but until it successfully transitions to new revenue sources and emerges from its litigation nightmares, I think its stock looks a bit risky. Having said that, investors should remember that Sierra Wireless has experiences its fair share of volatility as well, and investors should expect this IoT pure-play to see more of the same as it grows.