Is Qualcomm a Buy?

Qualcomm (QCOM -0.20%), the largest mobile chipmaker in the world, was once considered a sound investment for conservative investors. Its sales of mobile chipsets generated a stable stream of revenue, and its portfolio of wireless patents -- which gave it a cut of every smartphone sold worldwide -- supported its bottom line growth.

Qualcomm might initially seem like an attractive investment since it trades at just 12 times forward earnings and pays a forward dividend yield of nearly 5%. It's also raised that dividend every year since 2003. However, this troubled stock has a low multiple and a high yield because it shed a fifth of its value over the past 12 months.

Image source: Getty Images.

That decline, which left the stock significantly underperforming the Philadelphia Semiconductor Index's 4% gain, was caused by numerous concerns about its two core businesses. Let's review those issues to see if Qualcomm is worth buying at these levels.

Check out the latest Qualcomm earnings call transcript.

Why did Qualcomm lose its mojo?

Qualcomm generates most of its revenue from its lower-margin QCT (chipmaking) business, but it usually generates most of its profits from its higher-margin QTL (licensing) unit.

The QCT unit faces tough competition from cheaper chipmakers like MediaTek and big OEMs like Huawei, which replace Qualcomm's chips with their in-house designs. The QCT unit also stopped supplying baseband modems to Apple (AAPL 0.52%), which was a major customer until escalating legal disputes (over unpaid rebates and licensing fees) killed that long-term partnership.

The QTL unit faces a barrage of probes and lawsuits from regulators and OEMs, respectively, which claim that its cut of a device's wholesale price (up to 5%) is too high. They argue that Qualcomm should only take its cut based on the price of the wireless components instead of the entire device.

Image source: Getty Images.

This unit now faces an open rebellion. Apple halted its licensing payments in 2017, and Huawei followed suit shortly afterwards. Qualcomm signed a temporary licensing deal with Huawei last month, but its war with Apple is escalating, with multiple lawsuits across several countries.

These headwinds, along with the slowing demand for smartphones worldwide, caused Qualcomm's revenue and earnings growth to tumble over the past year.

Year-over-year growth. Source: Qualcomm quarterly earnings.

Qualcomm's non-GAAP EPS rose 25% annually last quarter, but that can mainly be attributed to the massive $30 billion buyback plan it initiated after its bid for NXP Semiconductors (NXPI 1.29%) failed.

Mind the "GAAP" and free cash flow levels...

Meanwhile, Qualcomm's legal fees, fines, breakup fees, stock-based compensation, and other messy "one-time" charges reduced its GAAP net income by hundreds of millions of dollars every quarter:

Year-over-year growth. Source: Qualcomm quarterly earnings.

Qualcomm might dismiss those charges as temporary headwinds, but it probably can't solve all these problems within the next few quarters. Moreover, those big reductions to its GAAP earnings caused its free cash flow (FCF) to plummet to a multi-year low.

QCOM Free Cash Flow (TTM) data by YCharts

That's worrisome for Qualcomm's dividend investors. Over the past 12 months, Qualcomm paid out 190% of its FCF as dividends. If its FCF levels continue to decline, Qualcomm's streak of dividend hikes could abruptly end.

Qualcomm's decision to spend $30 billion on buybacks is also troubling, since that cash would arguably be better spent on acquisitions to diversify its QCT and QTL businesses away from the tough mobile market. That's what Qualcomm initially planned to do with NXP, so it's frustrating to see it abandon that strategy to pursue buyback-buoyed earnings growth.

So is it time to buy Qualcomm?

Analysts expect Qualcomm's revenue to fall 10% this year as its earnings rise 5%. However, Qualcomm could miss those forecasts if it doesn't resolve its long list of legal issues in a timely manner.

Qualcomm's stock is cheap because most investors believe that those headwinds won't cease anytime soon. Plenty of other stocks are trading at low valuations and pay similar yields while facing fewer challenges, so it's tough to recommend buying Qualcomm until it gets its act together.