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Qualcomm's $10 Billion Stock Buyback Looks Smart

By Ashraf Eassa – May 22, 2018 at 10:27AM

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This Fool is a fan of Qualcomm's decision to scoop up a large portion of its own shares.

On May 9, wireless technology giant Qualcomm (QCOM -1.62%) announced a new stock repurchase program for $10 billion of the company's shares. This program, the company said, replaces a previous buyback authorization that had $1.2 billion remaining (so the net increase in Qualcomm's buyback firepower is $8.8 billion). 

Although I'm not always a fan of stock buybacks, in this case, with Qualcomm's shares trading where they are and given the size of the buyback relative to Qualcomm's overall market capitalization, I like this one.

Two Qualcomm mobile processors next to each other.

Image source: Qualcomm.

The goal of a stock buyback

Ultimately, the purpose of a stock buyback is to reduce the number of shares that a company has outstanding, which has the effect of boosting earnings per share for a given level of net income. Ideally, the boost in earnings per share leads to a higher stock price since stocks trade as a multiple of their earnings per share.

The best stock buybacks happen when the stock is beaten down and both management and the board of directors correctly believe that the stock is undervalued relative to the company's future prospects. Buying back the shares when they're low allows for the company to get the most out of each dollar that it pours into the share buybacks, since they can maximize the number of shares that get taken out of circulation. 

With that background in mind, it's not hard to understand why I like Qualcomm's buyback.

Qualcomm's stock is low, could be very undervalued

As of this writing, Qualcomm stock most recently closed at $56.95 per share, which is near the low-end of where the stock has traded over the last five years. It's also below the $82 per share that fellow chip giant Broadcom offered to buy the company for earlier this year. 

That being said, Qualcomm management says that it has "high confidence" that it can generate between $6.75 and $7.50 per share in non-GAAP earnings during its fiscal year 2019. If Qualcomm can pull that off, and as long as the market sees fit to assign an earnings multiple of between 10 times earnings and 15 times earnings, the stock could be worth anywhere from $67.50 and $112.50 per share. Even at the low end of that range, Qualcomm's shares would currently be materially undervalued and a share buyback at these levels would be smart.

It's also worth noting that Qualcomm's market capitalization is around $84 billion, so Qualcomm's $10 billion share repurchase would take around 12% of the company's shares out of circulation. That would drive a sizable increase in earnings per share. 

Not risk-free

There are risks that could keep Qualcomm from hitting its earnings per share target. For one, Qualcomm says that $1.50 to $2.25 of its projected fiscal year 2019 earnings per share will come from "licensing resolutions." 

For those of you unfamiliar with the story, Qualcomm's business depends heavily on collecting royalties on the selling prices of every 3G/4G LTE smartphone sold. Right now, two major players -- Apple and another unidentified smartphone maker (believed to be Huawei) --  have stopped paying Qualcomm royalties pending the result of litigation between the companies and Qualcomm. 

Qualcomm seems to be betting that these disputes will be settled in its favor. If that happens, this will drive a big earnings per share bump for the company during fiscal year 2019. There's no way for us to know how this will all shake out, but if Qualcomm is right, then that'd be great for the company's stock price. 

The risk is if that legal battle doesn't go Qualcomm's way, then not only could that additional $1.50 to $2.25 not materialize, but in a worst-case scenario, Qualcomm's licensing business could fall apart entirely. That would drive the company's earnings per share down from the $4.28 that it saw during fiscal year 2017. In that case, the stock could go lower -- potentially significantly so -- and buybacks at current levels wouldn't look as smart.

On balance, though, I like Qualcomm's newly authorized share repurchase program and think that it'll likely prove a net benefit to current Qualcomm stockholders. 

Ashraf Eassa owns shares of Qualcomm. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Broadcom Ltd. The Motley Fool has a disclosure policy.

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