My fellow Foolish colleague Leo Sun recently penned an interesting article arguing that Qualcomm's (NASDAQ:QCOM) share repurchases "enrich executives at the expense of its shareholders." He points out that a significant portion of Qualcomm's share repurchase activity (roughly 10%) over the last 12 months has been used to merely offset the dilution associated with share repurchases.

Although I do agree with some of the points Sun made -- in particular, given Qualcomm's business/share price performance, pay cuts rather than excessive executive compensation would certainly have been the way to go -- I disagree with his proposed alternative uses of that cash.

Should Qualcomm really be out acquiring more companies and/or boosting R&D spend?
Sun argues that instead of plowing its profits into stock repurchases, Qualcomm should boost its research and development spending and/or go out and buy other companies in order to better combat a number of competitive threats it faces.

In particular, Sun notes the following potential pressures that Qualcomm is currently dealing with or may need to deal with in the future:

  1. Intel (NASDAQ:INTC) may win a spot as a second source for the cellular modems inside of Apple's (NASDAQ:AAPL) flagship iPhones.
  2. The mobile chip market is becoming "saturated" and Qualcomm needs to invest to expand its business beyond it.
  3. Qualcomm needs to develop compelling enough high-end chips in order to win back spots in future Samsung (NASDAQOTH:SSNLF) flagship phones.

However, I would argue Qualcomm is already spending at appropriate levels to try to address these challenges.

As far as Intel goes, Qualcomm's stand-alone modems are already superior to anything Intel is currently shipping or will be shipping within the next year. If Intel is able to sufficiently close the gap with Qualcomm in order to be able to win an iPhone, I would consider this more of a major accomplishment for Intel rather than any "failing" on Qualcomm's part.

With respect to trying to diversity out of the mobile chip market, I think Qualcomm is doing a reasonable job there, especially as there are plenty of markets where Qualcomm's smartphone-focused technology can be repurposed for nonsmartphone applications. During the company's most recent fiscal year, around 10% of the revenues in its chip business came from nonsmartphone markets and over time I suspect this will continue to grow.

With the respect to the third point, although Qualcomm clearly slipped with its last generation Snapdragon 810 in terms of product quality/competitiveness, the indications so far indicate the company's next generation Snapdragon 820 processor is healthy. No company is perfect and mistakes happen, and the Snapdragon 810 was a powerful illustration of this

This isn't a guarantee Samsung will use Qualcomm's processors in its phones -- after all, Samsung may have strategic reasons beyond raw chip performance/features to try to use its Exynos chips more going forward than Qualcomm's Snapdragon. However, I don't think additional R&D spend at this point will help improve Qualcomm's products in a material fashion.

Another thing to keep in mind about raising R&D spend
It's also worth pointing out that share repurchases at the very least offset the dilution associated with share-based compensation and more aggressive ones actually lower the share count. Such buybacks amplify a company's earnings per share by dividing a fixed amount of net income by a smaller pool of shares.

In other words, share buybacks are a pretty quick and easy way to boost earnings-per-share.

If Qualcomm were to willy nilly boost its research and development spend, then this would have an adverse impact on the company's near-to-medium term profitability. The whole point of the buyback is to find a way to use the free cash flow that a company generates and return what it needs to shareholders.

Is the suggestion here really that Qualcomm should scale up its operating expenses to the point where it doesn't actually generate any free cash flow?

Buybacks are fine; in fact, I'd like to see more
Buybacks are fine, especially if company management believes the stock is materially undervalued. At this point, I would like to see Qualcomm get even more aggressive about buying back its shares. In addition to plowing as much of its free cash flow as possible into repurchasing shares (there is no need to let cash pile up further on the books), it might be interesting to see the company issue even more debt against its large overseas cash hoard to do such a repurchase.

After all, if management truly believes things are about to turn around for the company (particularly its chip business) now, more than ever, is the time for the company to buy with both hands. 

Ashraf Eassa owns shares of Intel and Qualcomm. The Motley Fool owns shares of and recommends Apple and 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.