Lumentum (LITE -1.78%) and Qualcomm (QCOM 0.35%) both provide essential components for smartphones. Lumentum produces 3D-sensing chips for advanced cameras, and Qualcomm is the world's largest producer of mobile chipsets, which bundle together CPUs, GPUs, and baseband modems for smartphone manufacturers.
Both stocks have generated impressive returns for long-term investors. Lumentum's stock has rallied nearly 400% over the past five years, while Qualcomm's stock has advanced over 250%. If we factor in reinvested dividends, Qualcomm generated a total return of more than 320%. But as we all know, past performance never guarantees future gains -- so let's take a fresh look at both chipmakers to see which is the better investment.
The differences between Lumentum and Qualcomm
Lumentum generated 90% of its revenue from its optical communications (OpComms) unit in fiscal 2020, which ended last June. This business sells optical chips to service providers and data center customers, as well as 3D-sensing chips for phones, cars, industrial machines, and 3D printers. The remaining 10% of its revenue came from its industrial laser unit, which sells lasers for manufacturing, inspection, and life science purposes.
Lumentum's top customer is Apple (AAPL -0.10%), which buys 3D sensing chips from its OpComms business. Orders from Apple accounted for 26% of Lumentum's sales last year.
Qualcomm generated more than three-quarters of its revenue from its chipmaking business in fiscal 2020, which ended last September. The rest mainly came from its licensing business, which earns a cut of every smartphone sold worldwide via its massive portfolio of wireless licenses. It generates most of its profits from its higher-margin licensing business, which often subsidizes the expansion of its lower-margin chipmaking unit.
Qualcomm's top customers are Apple, Oppo, Vivo, Samsung, Xiaomi, and Huawei, which each accounted for over 10% of its revenue last year. It previously faced revolts and lawsuits from several of those customers over its licensing fees, but those issues have been largely resolved. Qualcomm, unlike many other chipmakers, was also permitted to continue selling chips to blacklisted companies like Huawei via a special license.
Which chipmaker is growing faster?
Lumentum's revenue rose 7% to $1.68 billion last year, but that marked its slowest growth in four years as a 16% decline in laser revenue partly offset its 11% growth in OpComms revenue.
Lumentum's laser business had already been struggling with sluggish demand for its fiber lasers prior to the pandemic, and that slowdown intensified throughout the crisis as manufacturing plants shut down. Despite those challenges, Lumentum's adjusted earnings still rose 28% for the year as it cut costs and relied more heavily on higher-margin OpComms products.
In the first quarter of 2021, Lumentum's revenue grew less than 1% year-over-year to $452.4 million as a 29% decline in laser sales offset its 3% growth in OpComms sales. However, its gross and operating margins continued expanding and boosted its adjusted earnings 24%.
Lumentum expects its revenue to rise 2%-6% year-over-year in the second quarter, and for its adjusted earnings to grow 11%-24%. Analysts expect its revenue and earnings to rise 7% and 14%, respectively, this year as both businesses stabilize and accelerating sales of new 5G phones -- especially Apple's iPhone 12 -- drive demand for its 3D-sensing chips.
Qualcomm's adjusted revenue rose 12% to $21.7 billion last year, with 13% growth at its chipmaking business and 10% growth at its licensing business, and its adjusted earnings grew 18%.
Qualcomm expects its revenue to rise 51%-70% year-over-year in the first quarter of 2021, as Apple and its other top customers roll out new 5G smartphones. The recovering auto market, which is buoying demand for 4G and 5G telematics chips, should complement that growth. At the end of 2020, Qualcomm revealed that its automotive design pipeline was worth about $8 billion -- up from nearly $6.5 billion at the beginning of the year.
Qualcomm expects its adjusted earnings to grow 97%-117% year-over-year during the first quarter. Analysts expect its revenue and earnings to rise 40% and 70%, respectively, for the full year.
The obvious winner: Qualcomm
Lumentum trades at just 16 times forward earnings, which is lower than Qualcomm's forward P/E ratio of 22. However, Lumentum trades at a lower multiple because investors expect its weaker laser business to partly offset the growth of its OpComms business for the foreseeable future.
Meanwhile, Qualcomm's stock remains surprisingly cheap relative to its growth potential. It's resolved most of the legal challenges, including its clashes with Apple and Huawei, that throttled its growth in the past. It also pays a decent forward yield of 1.6%, while Lumentum has never paid a dividend.
In short, investors can pick a stable chipmaker that is still burdened by a weaker business, or stick with a resurgent one that is firing on all cylinders. Therefore, I firmly believe Qualcomm will outperform Lumentum this year.