Thesis For Growth
QUALCOMM, Inc. (NASDAQ:QCOM) is a global company founded in 1985 that designs, develops, manufactures, and markets digital telecommunications products and services. The company’s passion is “to continue to deliver the world’s most innovative wireless solutions.”
Perhaps the most interesting aspect of the company is the underlying licensing business model. As Qualcomm indicates: “the goal was simple: provide wireless companies with the R&D to bring theirinnovations to market.” Qualcomm has gone about achieving this goal primarily through developing breakthrough technology and making strategic partnerships. The company then openly licenses the innovations across the industry. In essence, the licensing aspect of the business is very similar to McDonald’s (MCD) renting land or selling equipment to McDonald’s franchisees. Qualcomm is responsible for the product, but they’re able to leverage it well.
Now it should be made clear that the majority of QUALCOMM, Inc. (NASDAQ:QCOM)’s revenue comes from the sale of wireless chips. In turn, the company faces a host of competition in this area from the likes of Intel Corporation (NASDAQ:INTC), Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930), NVIDIA Corporation (NASDAQ:NVDA) and others. However, the licensing model appears to be at both the heart of the company’s mission and future profitability, as nearly three fourths of the company’s earnings are derived from this segment. Thus, in the spirit of due diligence, one would obviously want to determine the market for chips. But more importantly, an investor would want to know how susceptible the licensing business is to future threats.
Qualcomm holds thousands of wireless intellectual property patents, which allows the company to charge nearly every handset maker a royalty fee. The risk associated with this strategy is that the licensing revenues are dependent on the pricing of handsets – something Qualcomm does not control. Still it’s an attractive business strategy and one that has worked well thus far. In addition, QUALCOMM, Inc. (NASDAQ:QCOM) has a firm grip on the technology that 3G networks are based on, but less of a foothold in the 4G market. Sequentially, one might believe that this would be a lasting disadvantage moving forward. Yet many of the 4G phones today are backward-compatible with 3G networks. And of course, an innovative company like Qualcomm has the ability to expand upon its current and future capabilities.
Qualcomm likes to indicate: “innovation is more than something we do, it’s who we are.” To this point, we have seen a strong track record of providing valuable and lasting originality. But even without the well executed R&D, the company still stands a reasonable shot at creating solid business results. Qualcomm has a business unit – Qualcomm Ventures – that has been making investments in technology focused start-ups since 2000. QUALCOMM, Inc. (NASDAQ:QCOM) is able to utilize its own capabilities to expand upon the acquired partnerships.
Current and on the horizon products include the Snapdraggon 800 chipset which is being used by the new Samsung Galaxy S4 along with Qualcomm’s development of its own smartwatch – the Toq – which should be available shortly. It’s expected that smartwatches will see an explosion in demand in the next year.
Overall, Qualcomm appears poised to grow with a variety of differentiating opportunities. Selling chips remains as their largest revenue generator, but the licensing business model – where, due to very high margins, the bulk of Qualcomm’s earnings come from – appears especially compelling. With a growing middle class and emerging markets, Qualcomm stands to benefit from a variety of inherent catalysts. Whether the technology is developed in house or acquired through its venture capital capabilities, Qualcomm has the size and drive to continuously search for the next big thing in wireless. Finally, the company has taken the initiative far beyond licensing and is developing new and interesting products.
15 Years of Results
Qualcomm has grown earnings (orange line) at a compound rate of 27.6% since 1999, resulting in a $115+ billion dollar market cap. In addition, Qualcomm’s earnings have risen from $0.34 per share in 1999, to today’s forecasted earnings per share of approximately $4.54 for 2013. Further, Qualcomm initiated a dividend (pink line) in 2003 and has been able to increase this payout at a robust pace over the last decade. For a look at how the market has historically valued Qualcomm, see the relationship between the price (black line) and earnings of the company as depicted on the Earnings and Price Correlated F.A.S.T. Graph below.
Here we see that Qualcomm’s market price previously began to deviate from its justified earnings growth; starting to become overvalued in 1999 and coming back to fair value around 2002. Today, Qualcomm appears undervalued in relation to both its historical earnings and relative valuation.
In tandem with the strong earnings growth, Qualcomm’s shareholders have enjoyed a compound annual return of 23.7% which correlates closely with the 27.6% growth rate in earnings per share. A hypothetical $10,000 investment in Qualcomm on 12/31/1998 would have grown to a total value of $229,117.14, without reinvesting dividends. Said differently, Qualcomm shareholders have enjoyed total returns that were roughly 14 times the value that would have been achieved by investing in the S&P 500 over the same time period. It’s also interesting to note that an investor would have received about 8 times the amount of dividend income compared to the index as well.
Looking to the Future
But of course – as the saying goes – past performance does not guarantee future results. Thus while a strong operating history provides a fundamental platform for evaluating a company, it does not by itself indicate a buy or sell decision. Instead, an investor must have an understanding of the past while simultaneously thinking the investment through to its logical, if not understated, conclusion.
In the opening paragraphs a variety of potential catalysts and opportunities for growth were described. It follows that the probabilities of these outcomes should be the guide for one’s investment focus. Yet it is still useful to determine whether or not your predictions seem reasonable.
Forty-four leading analysts reporting to Standard & Poor’s Capital IQ come to a consensus 5-year annual estimated return grow rate for Qualcomm of 16%. In addition, Qualcomm is currently trading at a P/E of 15.2, which is inside the “value corridor” (defined by the orange lines) of a maximum P/E of 19.2. If the earnings materialize as forecast, Qualcomm’s valuation would be $149.14 at the end of 2018, which would be a 17.8% annualized rate of return including dividends. A graphical representation of this calculation can be seen in the Estimated Earnings and Return Calculator below.
Now, it’s paramount to remember that this is simply a calculator. Specifically, the estimated total return is a default based on the consensus of the analysts following the stock. The consensus includes the long-term growth rate along with specific earnings estimates for the next two upcoming years. Further, the dividend payout ratio is presumed to stay the same and grow with earnings. Taken collectively, this graph provides a very strong baseline for how analysts are presently viewing this company. However, a F.A.S.T. Graphs subscriber is also able to change these estimates to fit their own thesis or scenario analysis.
Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in Qualcomm to an equal investment in a 10-year Treasury bond, illustrates that Qualcomm’s expected earnings would be 4.6 times that of the 10-year Treasury bond interest. This comparison can be seen in the 10-year Earnings Yield Estimate table below.
Finally, it’s important to underscore the idea that all companies derive their underlying value from the cash flows (earnings) that they are capable of generating for their owners. Therefore, it should be the expectation of a prudent investor that – in the long-run – the likely future earnings of a company justify the price you pay. Fundamentally, this means appropriately addressing these two questions: “in what should I invest?” and “at what time?” In viewing the past history and future prospects of Qualcomm we have learned that Qualcomm appears to be a strong company with solid upcoming opportunities. However, as always, we recommend that the reader conduct his or her own thorough due diligence.
Disclosure: Long MCD, QCOM at the time of writing.