At first glance, chipmakers NVIDIA (NVDA 3.96%) and Qualcomm (QCOM +0.23%) are very different investments, the former focused on graphics processing units (GPUs) and the latter on connectivity semiconductors and related equipment. But while the hardware is certainly not the same, the lines between the two worlds are beginning to blur.
Thanks to new WiFi tech and the early rollout of 5G mobile networks, connectivity is more important than ever. But GPUs are finding an increasing number of new end uses to complement new connectivity tech. NVIDIA and Qualcomm are very different technologists, and the stocks may appeal to two different types of investors, but both should be core holdings in tech portfolios.
Not just video games and smartphones
GPUs and connectivity chips have both moved far beyond their initial end markets of video games and smartphones. Connectivity chips like what Qualcomm designs are important, especially with WiFi 6 and 5G technology just getting rolling.
The upgrade cycle should provide a boon for Qualcomm and its peers as the faster data transfer tech slowly replaces legacy systems and smartphones. Plus, the Internet of Things (IoT) movement is still ongoing. Researcher Gartner said it expects there will be over 5.8 billion IoT devices in operation at the end of 2020 (a 20% increase over 2019), led by utility company and government agency use.
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But along with a growing number of connected devices and the enhancement of current mobile data capabilities, the ability to compute faster data transmission is equally important. That's where GPUs are coming in, and NVIDIA has long been the leading pioneer of the GPU chip type.
Like Qualcomm, NVIDIA is in the early stages of an upgrade cycle with new video chips used for video games and professional design work. Besides that, though, the GPU is finding plenty of new use cases in computing large amounts of data, including in the IoT and telecom movement and especially in data centers, as AI is becoming an important part of organizations' operational needs.
While both companies' revenue has been cyclical -- the norm for all things related to hardware manufacturing -- it's NVIDIA that has been growing faster and has the bigger long-term potential with new uses for its GPUs only just beginning to be tapped.
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Profit margins are key
Both NVIDIA and Qualcomm also focus on the most profitable part of the hardware market: Design and licensing. Rather than manufacture and sell semiconductors themselves, both companies license out their technology systems for manufacturers, IoT system operators, data center builders, etc. As a result, both have historically high operating profit margins and return on investment, although Qualcomm recently came out of a slump on both fronts, while NVIDIA's metrics have continued to chug higher on average.
Data by YCharts.
That's important as high profitability means the two technologists are able to continue investing cash back into research and development to promote future growth and innovation. However, over time it's NVIDIA that has been able to convert that profitability into a strong balance sheet. Cash, equivalents, and short-term investments at NVIDIA totaled $10.9 billion at the end of January 2020, and long-term debt was $1.99 billion. Larger Qualcomm had $11.4 billion in cash, equivalents, and short-term investments, but $13.4 billion in debt.
Different valuations, but two very different stocks
A higher rate of growth and stronger balance sheet equate to a much steeper premium on NVIDIA shares. NVIDIA stock trades for 38.6 times the last year's worth of free cash flow (money left after basic operating and capital expenses are paid) versus just 12.5 times for Qualcomm. Qualcomm also pays a dividend currently yielding 3.5% versus just a 0.25% yield on NVIDIA. While both are quality semiconductor investments, Qualcomm is certainly tilted more toward investors looking for value and income.
However, rather than simply call one stock a better buy than the other, or suitable for one type of investor over another, I view the two chip giants as part of a cohesive investment in the future of technology, with Qualcomm covering the boom in connected things and NVIDIA the need for faster computational power.
The two product portfolios tackle different aspects of electronic systems, with an increasing overlap in the type of device. However, both are getting a boost from current upgrade cycles, as well as playing in new markets that are expected to grow for the foreseeable future. While growth investors may skew toward NVIDIA and dividend seekers toward Qualcomm, both are worthy of inclusion in portfolios of investors of all kinds.
