Qualcomm (NASDAQ:QCOM) shares sank after the company posted disappointing quarterly earnings after the market closed Nov. 5. Shares closed Monday down about 10% from Nov. 5's closing price. In addition to weak results that missed analyst expectations, the company announced its business practices were under investigation in China and the United States. Shares of the chip giant are now down about 7% year to date, which is a far worse performance than the S&P 500 Index, which has registered a 10% gain so far this year.
With all this going on, it might seem ridiculous to recommend Qualcomm as a dividend play. But the truth is, Qualcomm actually has a lot to offer anyone looking to produce income from their investments. Let's take a look at why.
The power of Qualcomm's dividend
The technology sector might not seem like a haven for income seekers. After all, technology companies may remind investors of the bursting of the 1999-2000 tech bubble, which makes tech stocks seem far too speculative and risky for dividend investors. But things have changed. There is a group of large-cap technology stocks arguably just as mature and stable as many others in the market. Some of these, including Qualcomm, now pay strong dividends and have built track records of dividend growth that should make them very attractive to dividend investors.
Even after Qualcomm first initiated its dividend in the aftermath of the technology bubble, it was rarely a good dividend stock. That's because Qualcomm spent most of its time as a high-flying growth stock that traded for lofty valuation multiples. Because of this, Qualcomm's dividend yield was typically very low, which never made it an ideal pick for income investors.
Recently, though, this trend has reversed. Qualcomm has aggressively raised its dividend over the past several years, and now it's a strong dividend stock. Over the past five years, Qualcomm has raised its dividend at a 20% compound annual clip. At its recent stock price of $68 per share, Qualcomm's dividend now yields nearly 2.5%. For comparison, six months ago, Qualcomm offered just a 1.7% yield, because its stock price was much higher than it is now. According to YCharts, Qualcomm's dividend yield right now is at its highest point in the last five years.
Qualcomm's underlying strength
The reason Qualcomm can afford to raise its dividend so much is that it is a cash-generating machine. Qualcomm is huge company, worth $115 billion in market capitalization. It has reached a point of size and scale that allows it to produce strong free cash flow, without the need to reinvest all of its revenue back into the business, as many small technology companies do. For instance, despite its weak quarterly earnings, Qualcomm still generated $7.7 billion of free cash flow in fiscal 2014.
Qualcomm still has plenty of room left for future dividend increases. Consider that Qualcomm's dividend cost the company $2.5 billion last year. That makes up just one-third of the company's free cash flow. Even if Qualcomm's free cash flow stalls from here, which is unlikely given the fact that management still expects high-single-digit revenue growth and double-digit earnings growth, there's still ample room for dividend growth going forward.
If Qualcomm maintains 20% dividend growth over the next five years, which is definitely possible, the stock would yield 6.2% for those investors who buy today. This is the concept of yield on cost, which proves the amazing power of rising dividends. Yield on cost demonstrates a company's forward-looking yield that takes dividend growth into account. As a bonus, if you reinvest dividends, your yield on cost rises even faster.
The major takeaway is that despite a poor earnings report, one quarter doesn't make or break a huge company like Qualcomm. The investigations in China and the U.S. may result in financial penalties, but these are short-term issues -- not a real deterioration of the business. Qualcomm's dividend growth is truly impressive, and reason for income investors to consider adding the stock to their portfolios.
Bob Ciura has no position in any stocks mentioned. The Motley Fool owns shares of Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.