Please ensure Javascript is enabled for purposes of website accessibility

Why I'm Selling Qualcomm

By Evan Niu, CFA - Jun 8, 2015 at 3:03PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

This Fool has held Qualcomm for over two years, and the mobile chip giant has lagged the broader market for the whole time. Is it time to move on?

As a huge advocate of the mobile revolution, I found that it simply made sense to invest in Qualcomm (QCOM 2.03%). After all, the company's technology powers all modern smartphones, while its chip business simultaneously provides many of the crucial components to those same devices.

Yet here I stand after holding shares for over two years, and the stock's performance has been rather disappointing to say the least. This is how Qualcomm has performed compared with the broader market throughout the duration of my ownership.

QCOM Chart

QCOM data by YCharts

Not including dividends, my position has gained a paltry 2% while the S&P 500 and Nasdaq Composite marched steadily higher. Of course, past performance is no guarantee of future results, and if anything, underperforming shares can be an opportunity in disguise if the underlying business remains strong and the market is being myopic. But combined with the underperformance, I'm starting to see some potential longer-term cracks in Qualcomm's business that are making me question its future prospects. In fact, I've decided to sell Qualcomm once the Fool's trading policy permits.

On valuation
In some ways, Qualcomm represents the Intel (INTC 0.13%) of the mobile world. It was quite a symbolic milestone when Qualcomm's market cap overtook Intel's for the first time, although Intel has since reclaimed a higher valuation. However, if we look at how the two companies stack up right now, Qualcomm's premium valuation relative to Intel may not be fully justified.

Metric

Qualcomm

Intel

P/E

16.3

13.7

P/S

4.1

2.7

Revenue growth (TTM)

6.9%

5.7%

Operating margin (TTM)

26.7%

27.4%

Return on equity (TTM)

18.8%

20.8%

TTM = trailing 12 months. Source: Reuters.

Qualcomm trades at a premium relative to Intel's valuation metrics, yet fundamental metrics related to growth and profitability don't do much to justify the relative premium.

On royalties
Qualcomm has a lock on 3G technologies, but Qualcomm has a relatively weaker hold on 4G technologies. To be clear, Qualcomm still enjoys its fair share of royalties, but its average royalty rate is undeniably on the decline. Its average royalty rate has fallen from an estimated 4.3% in 2008 to 3.2% in 2013.

There are a couple of other royalty headwinds going forward. Since Qualcomm's royalty depends on the prices of phones, the continued hardware commoditization that's taking place will hurt Qualcomm's piece of the action. Additionally, Qualcomm has been having trouble collecting its royalties in China, believing that local OEMs were underreporting their shipments in order to skirt paying up.

None of this is to say that Qualcomm's royalty business is falling apart; the licensing business saw revenue jump 17% last quarter. Rather, my concern is just that there are some noteworthy challenges going forward.

On Apple, Samsung, and chips
At this point, the two dominant smartphone vendors, Apple and Samsung, comprise roughly half of Qualcomm's total revenue. That's a pretty big risk in terms of customer concentration, particularly as their combined influence has only grown over the years.

Looking longer term, there is a distinct possibility that both Apple and Samsung have strategic interests in moving away from Qualcomm whenever technologically feasible. Samsung just booted Qualcomm's applications processors out of the Galaxy S6, and while Qualcomm feels confident that it can win the South Korean conglomerate back over, it's far from a lock, and it intuitively makes sense that Samsung will want to continue using its own silicon. Apple predominantly buys cellular basebands from Qualcomm, but the Mac maker is probably working on building its own in-house solution as well.

Again, there is no imminent doom in these critical customer relationships, but at the same time it's quite conceivable that Apple and Samsung will slowly but surely continue their ongoing transitions toward in-house designs. Those transitions will undoubtedly take many years to play out, but I'd rather not wait around for it to happen.

Qualcomm has built an undeniably strong business, but a great company doesn't always equal a great stock (and vice versa). We Fools tend to look for stocks that have the potential to outperform the broader market in the long term, and I'm not so sure that Qualcomm can.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

QUALCOMM Incorporated Stock Quote
QUALCOMM Incorporated
QCOM
$127.64 (2.03%) $2.54
Intel Corporation Stock Quote
Intel Corporation
INTC
$38.66 (0.13%) $0.05
Apple Inc. Stock Quote
Apple Inc.
AAPL
$141.76 (0.07%) $0.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
336%
 
S&P 500 Returns
115%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 06/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.