Qualcomm (NASDAQ:QCOM) shares plunged over 15% on Nov. 19, even though the mobile chipmaker posted better-than-expected fourth quarter earnings. Revenue slid 8% annually to $5.45 billion, but beat expectations by $240 million. Adjusted earnings fell 28% to $0.91 per share, exceeding estimates by five cents.
Chipmaking revenue plunged 25% due to Samsung's (NASDAQOTH:SSNLF) use of Exynos processors instead of Snapdragons in its flagship devices, market share gains for the iPhone, and competitive pressure from lower-end rivals. Licensing revenue slid 1% due to licensing disputes with Chinese OEMs.
None of those declines should surprise Qualcomm investors. But looking ahead, Qualcomm expects first quarter sales to fall 20% annually to $5.6 billion and adjusted EPS to drop 35% to $0.85. Analysts had expected a much milder decline to $5.8 billion in sales and $1.08 in earnings. To make matters worse, Qualcomm stopped offering full-year sales and earnings guidance.
That double whammy of bad news caused many investors to flee. I did the opposite, however, and bought some shares. Let's discuss three big reasons value-seeking investors should consider doing the same.
1. Dividends and valuations
Over the past 12 months, Qualcomm paid out 64% of its free cash flow as dividends. At current prices, the stock pays a forward annual yield of 3.4%, which is higher than the S&P 500's current yield of 2%. Qualcomm has also raised its dividend for 12 straight years. Plus, based on its FCF payout ratio, Qualcomm still has room to grow its dividend.
Qualcomm is also fairly cheap at 17 times trailing earnings, compared to the average P/E of 22 for the communication equipment industry. Qualcomm trades at just 11 times forward earnings, compared to the S&P 500's forward P/E for 17. In my opinion, Qualcomm's decent yield and cheap multiples should set a floor for how low the stock can go.
2. Focus on the licensing business
Qualcomm's chipmaking unit has certainly seen better days given its 73% year-over-year decline in operating profit last quarter. But even though the chipmaking division accounted for two-thirds of Qualcomm's non-GAAP revenue last quarter, it only generated 16% of its pre-tax earnings.
Qualcomm's licensing business, which licenses CDMA technologies, earns a 3% to 5% cut of the wholesale price of every 3G/4G smartphone shipped worldwide. That unit accounted for a third of Qualcomm's revenue last quarter, but generated 86% of Qualcomm's pre-tax earnings thanks to its higher margins. (The combined pre-tax earnings total for chips and licensing exceeds 100% due to non-GAAP reconciling items.)
Qualcomm generates half its sales from China, where licensing revenue and operating profit are throttled by Chinese OEMs under-reporting shipments and paying Qualcomm lower licensing fees. In response, Qualcomm is pushing Chinese OEMs to sign new long-term patent licensing agreements. ZTE has signed such an agreement, but Lenovo and Xiaomi, the two top smartphone makers in China, still haven't. Qualcomm hopes to clear up these issues by next year. If it does, the licensing unit could receive a significant tailwind from back royalties.
3. The chipmaking business might bounce back
Qualcomm admittedly dropped the ball with the Snapdragon 810, which suffered from overheating issues. That fumble left it vulnerable to cheaper rivals like MediaTek, and was likely the reason that Samsung started using its own Exynos processors.
Qualcomm believes that it can atone for those mistakes with the Snapdragon 820, which is reportedly 50% more powerful than Samsung's top-tier Exynos 7420. South Korea's Electronic Times claims that Samsung will install the 820 in its Galaxy S7 in "some markets". The 820 is also expected to power Xiaomi's latest flagship, the Mi 5.
Qualcomm is also expanding into other markets beyond smartphones and tablets. In October, Qualcomm started sampling its ARM-licensed data center chips to major data centers. Qualcomm claims that its server chips "will be competitive in performance and price" with Intel's (NASDAQ:INTC). Qualcomm is also battling Intel in drones with competing reference designs for cheaper quadcopters. Qualcomm and Intel both support different communication standards for the Internet of Things, which they hope can drive sales of their chips into wearables, action cameras, smart appliances, and connected cars. Just as the growth of these markets can help Intel diversify away from PC chips, they can help Qualcomm grow beyond mobile devices.
More upside than downside
Qualcomm admittedly faces a lot of problems down the road. Chinese OEM licensing issues could drag out, the Snapdragon 820 might fail to impress, and Intel could prevent Qualcomm from fully expanding into new markets for connected devices. But for now, I think the stock's upside potential outweighs its downside risks, and I'm willing to be paid a 3.4% dividend for waiting it out.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Qualcomm. The Motley Fool recommends Intel. 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.