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Why I Bought More Shares of Qualcomm Inc.

By Leo Sun – Feb 26, 2016 at 9:30AM

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I just bought some more shares of this battered chipmaker, but should you?

Shares of Qualcomm (QCOM -2.01%) have fallen 30% over the past 12 months due to concerns about lower cost rivals, Chinese OEMs under-reporting shipments to pay lower licensing fees, and new antitrust probes. But after the stock slipped into the low-to-mid $40s, I added some more shares to my existing position, which I started last November. Here are my top three reasons for doing so.

Source: Qualcomm.

1. The valuation, dividend, and buybacks
At $50, Qualcomm trades at just 17 times earnings which is lower than the industry average P/E of 18. Looking ahead, Qualcomm trades at just 11 times forward earnings. Analysts expect Qualcomm's annual earnings to grow 12% per year over the next five years, which gives it a 5-year PEG ratio of 1. Since a PEG ratio under 1 is "undervalued," the stock looks fairly cheap at or under the $50 level.

Qualcomm also pays a forward annual dividend yield of 3.9%, which is significantly higher than the S&P 500's average yield of 2.3%. That yield is also close to a multi-year high for the company, due to the stock's precipitous decline.

Over the past 12 months, Qualcomm paid out 58% of its free cash flow of $5 billion as dividends. It also spent nearly $11 billion on debt-fueled buybacks. I've previously expressed my distaste for Qualcomm's buybacks, but when combined with its low valuation and historically high dividend, they can limit the stock's downside from current prices.

2. Licensing revenues could rise through 2020
A common bearish argument against Qualcomm is that its CDMA licensing business, which accounted for nearly 80% of its pre-tax earnings last quarter, will experience a margin contraction due to regulatory demands. In the past, Qualcomm took up to 3% to 5% cut of the wholesale price of every smartphone shipped worldwide.

But with smartphone margins becoming paper thin, regulators and OEMs have revolted against those rates. Chinese regulators fined Qualcomm and forced it to collect royalties based on 65% of the net selling price of a handset, which is slightly lower than the wholesale price. South Korea and Taiwan recently followed China's lead with new probes, and Korean smartphone giant LG independently disputed the fees. Other OEMs in China underreported shipments to pay lower fees, forcing Qualcomm to pursue new licensing agreements. All those factors caused the unit's revenue and operating profit to respectively decline 12% and 15% annually.

During last quarter's earnings, Qualcomm forecast that licensing revenues would come in between $7.3 billion to $8 billion in 2016, which would represent an 8.1% decline to 0.7% growth from 2015. But during a recent analyst day presentation, Qualcomm presented a rosier long-term forecast for the business, claiming that the unit's annual revenues would rise to "over $10 billion" in fiscal 2020. Qualcomm believes that growth will be driven by a better product mix, growth in new licensing opportunities, licensing of non-3G/4G patents in China, and the resolution of current disputes. If Qualcomm's forecast is accurate, the lull in licensing fees could pass after it secures new agreements and diversifies its patent portfolio.

3. Growth opportunities for the chipmaking unit
Meanwhile, Qualcomm's chipmaking unit lost market share in application processors and baseband modems last year due to Samsung's (NASDAQOTH: SSNLF) decision to use its own silicon in its flagship devices and competition from its lower-cost rival MediaTek. Those challenges caused the chipmaking unit's revenue to decline 22% annually last quarter as operating profit plummeted 49%.

However, Qualcomm has taken big steps to boost the chipmaking unit's growth again. On the mobile front, it inked a new deal with Samsung to put its chips back into "some" of its new flagship devices, launched the new flagship Snapdragon 820 for other premium phones, and unveiled new mid-range processors to widen its moat against MediaTek.

To diversify away from mobile devices, Qualcomm introduced new chips for connected cars, cameras, drones, and data centers. During its analyst day presentation, Qualcomm presented a chart which illustrated why it was diversifying away from mobile chips:

Source: Qualcomm.

Last year, Qualcomm also pulled a few SoC action camera contracts away from Ambarella (AMBA -3.58%), a major maker of image processing SoCs for drones and connected cameras. Recent rumors claim that Qualcomm is now pursuing major Ambarella customers like drone maker DJI Innovations and action camera leader GoPro. It also started sampling its 64-bit server chips in tier 1 data centers last year -- a move which market leader Intel is likely watching closely.

Should you buy Qualcomm?
Qualcomm's stock looks cheap, and its recent deals and forecasts look promising. However, its future still depends on its ability to resolve current disputes with OEMs and regulators without new ones popping up, and its ability to stay ahead of rivals like MediaTek and Intel in new markets. Therefore, investors should carefully weigh Qualcomm's strengths and weaknesses before buying any shares.

Leo Sun owns shares of Qualcomm. The Motley Fool owns shares of and recommends Ambarella, GoPro, 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.

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Stocks Mentioned

QUALCOMM Incorporated Stock Quote
QUALCOMM Incorporated
QCOM
$121.19 (-2.01%) $-2.49
Intel Corporation Stock Quote
Intel Corporation
INTC
$27.52 (-1.96%) $0.55
Ambarella, Inc. Stock Quote
Ambarella, Inc.
AMBA
$58.47 (-3.58%) $-2.17
GoPro, Inc. Stock Quote
GoPro, Inc.
GPRO
$5.03 (-1.76%) $0.09

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

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