Qualcomm (QCOM +0.62%) stock has corrected significantly, falling by about 20% over the previous month. However, bulls seem to ignore Qualcomm's near-ideal market position in the smartphone chipset market, an industry on track for massive growth. This possibility alone gives investors good reason to treat the post-earnings sell-off in this chip stock as a buying opportunity.
The underappreciated bull story
Qualcomm's chipsets act as the "brain" of a smartphone, receiving and carrying out essential commands. For now, most smartphone manufacturers depend on Qualcomm's chipsets, technology that Qualcomm licenses to other manufacturers.
This has become particularly important amid the rising popularity of the 5G devices. Whereas the previous 4G standard brought speeds of between 12-36 megabytes per second (Mbps), 5G speeds commonly reach 300 Mbps and beyond.
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Although the government once declared Qualcomm a monopoly, the company's attorneys persuaded an appeals court to overturn the decision. Moreover, Apple (AAPL 0.32%), who pursued lawsuits against Qualcomm for years over royalty costs related to the chipsets, dropped its legal challenge in 2019 amid the emergence of 5G. Instead, Apple bought Intel's smartphone chipset business, presumably hoping to develop a competing chipset.
Now, all major smartphone manufacturers produce 5G devices. Consequently, Grand View Research estimates a compound annual growth rate (CAGR) for the industry of 63% through 2027.
Companies such as Samsung and Taiwan-based MediaTek produce 5G chipsets. Still, Samsung's chip only goes into its phones, and MediaTek has only gained a following with lesser-known Asian manufacturers. For this reason, Qualcomm will probably claim most of this growth for the foreseeable future.
Qualcomm's latest earnings figures seem to reflect that dominance. In fiscal 2020, the pandemic's effects early in the year dragged down the company's full-year performance; revenue fell about 3% for the year, while net income grew a modest 18%. But the company seemed to recover robustly by the end of that year. In Q4 2020, GAAP revenue rose by 73%, while net income increased 485% year over year. And in Q1 2021, the most recent quarter, revenue and GAAP net income increased 62% and 165% year over year.
Effects on Qualcomm stock
Investors have noticed those rising revenues and earnings; Qualcomm stock has surged by just over 60% over the last year. Still, this also accounts for the recent correction that sent Qualcomm falling over the previous few weeks.
Following the Feb. 3 earnings report, investors dumped Qualcomm shares, citing what was at the time a nearly 90% increase in the stock over the previous 12 months and concerns over a chip shortage.
However, the recent decline has further discounted Qualcomm stock. Now, the stock trades at 22 times earnings, down from a 28 P/E ratio before the earnings announcement. Hence, not only do new investors pay less than the current S&P 500 average P/E ratio of about 38, but they also benefit from massive revenue and earnings growth.
On top of the fast-growing profits, investors will receive $2.60 per share in dividends every year. Though that amounts to a yield of only 2%, Qualcomm's annual payout has risen every year since dividend payments began in 2003.
Also, the company can afford this payout. In fiscal 2020, $4.4 billion in free cash flow covered the $2.9 billion dividend expense for that year.
Additionally, while the $15.7 billion in combined short and long-term debt represents a significant burden, the remaining free cash flow also covered interest expenses of about $600 million. This means that although debt levels changed little over the last 12 months, those obligations pose no obvious danger to the company's stability.
The likely direction of Qualcomm stock
Even considering its potential issues, investors appear to have a buying opportunity in Qualcomm stock. Yes, the stock price experienced massive gains in 2020, and perhaps the time had come for a correction. Moreover, chip shortages and the possibility of competition remain ongoing threats.
However, in the end, new investors will pay 22 times earnings for up to triple-digit earnings growth. Moreover, unless and until a competing chipset hits the market on a larger scale, the 60%-plus of forecasted industry growth will primarily accrue to Qualcomm. Given the tremendous possibilities for increasing profits and its low valuation, Qualcomm's potential returns appear to significantly outweigh its risks.
