Right now, Qualcomm (NASDAQ:QCOM) is hardly Wall Street's most beloved chip stock. Fellow Fool Evan Niu recently discussed his frustration with the performance of Qualcomm stock in an excellent article on why he's selling Qualcomm shares. Although I understand Niu's frustration (I've been holding Qualcomm for a while and my position is actually down), I think things will get better for the company over the next year or so.
Commensurate with that view, I went ahead and increased my Qualcomm holdings by 150%.
Why Qualcomm stock is down
I would argue that the challenges facing Qualcomm are real, particularly in its chip business. Apple (NASDAQ:AAPL) and Samsung (NASDAQOTH: SSNLF) together command much, if not most, of the high-end smartphone market, and Samsung -- which had been quite keen to use Qualcomm's chips in its flagship Galaxy S/Galaxy Note products -- chose to use its own Exynos processor in the S6 exclusively.
In the mid-range and low-end, Qualcomm faces competition from the likes of MediaTek and, in some segments, Spreadtrum.
Qualcomm has also run into trouble in its wireless technology licensing business, which makes up the majority of its operating income. You might remember the difficulties that Qualcomm had in trying to collect royalties from certain vendors in China -- the company had to make significant concessions to collect royalties on just 65% of the selling prices of wireless devices.
What could make the stock rise?
I view Qualcomm's technology licensing business as a stable "cash cow". The business' revenue is more or less a function of the royalty rate that Qualcomm is able to command and "total reported device sales." The smartphone market is growing, and it seems as though cellular technologies could become more prominent in other areas of computing, spanning from notebook PCs to the Internet of Things.
That's a pretty solid foundation for the company's "cash cow" wireless technology licensing business for years to come.
The chip business, on the other hand, is a bit trickier. MediaTek isn't going away, Samsung's own applications processors seem to be improving, and if Intel (NASDAQ:INTC) ever gets its act together in smartphones, the competitive environment for merchant smartphone silicon will become fiercer.
If Qualcomm can stay ahead of the competition when all is said and done, however -- and I believe Qualcomm's technology is best in class -- the company should retain solid market share, and should benefit from industrywide smartphone unit growth.
Qualcomm also has ambitions to compete outside of the traditional smartphone chip market and is aiming to attack the data center, where unit volumes are lower but average selling prices (and gross profit margins) are higher. Whether Qualcomm will ultimately be successful in leveraging its mobile technology in servers remains to be seen, as competing against Intel will be quite tough.
The critical piece of this puzzle
I realize that the above reasoning is hardly a glowing endorsement of Qualcomm's business; this is "just" a well-run company that holds a leadership position in the competitive, but growing, market for smartphone chips. If Qualcomm traded at a nosebleed valuation, this would hardly be a compelling investment case.
But it doesn't.
Qualcomm is currently forecasting GAAP diluted earnings per share for the current fiscal year between $3.28 and $3.68, $3.48 at the midpoint. At roughly 19.2 times earnings, that's not terribly expensive, nor is it inexpensive. A bear might even argue that this multiple is too high considering these numbers represent about a 25% decline at this midpoint.
That's fair. However, I would argue that the decline is due to a "perfect storm" of negative factors. Qualcomm lost the Galaxy S6, it -- by the company's own admission -- faced "heightened competition" in China (against an increasingly strong MediaTek), and the merchant market for higher-end chips became tight as Apple (NASDAQ:AAPL) -- which designs its own chips – gained share.
I don't expect any of these factors to represent persistent threats. Apple may very well continue to gain share with future iPhones, but I don't think the magnitude of such share gains will be as large as what we saw with the iPhone 6 cycle. Qualcomm is already out of the S6 (save for a stand-alone modem in some regions), so there's very limited downside with respect to the Galaxy S7.
And, finally, with Qualcomm developing what seems to be an aggressive set of products in the mid-range, bringing its high-end modems to mid-range and even low-end chips, it is in a good position to defend or perhaps even regain share in that portion of the market over the next year or so.
In a nutshell, it seems pretty reasonable to expect that Qualcomm will see earnings growth in the medium-to-long-term.
One more thing
Another factor that I think is important is that Qualcomm is becoming more aggressive in terms of returning capital to shareholders. The company announced a $15 billion buyback program back in March, and even said that it would buy back $10 billion worth of stock within twelve months. At the same time, it also raised its dividend by 14%.
If Qualcomm can consistently grow its dividend and buy back shares at a robust clip, it may be able to make its shares more attractive to potential investors.