Qualcomm, Inc. (NASDAQ:QCOM) is a key player in the semiconductor industry, focusing primarily, at this point, on smartphones. In the past, the company’s fortunes soared alongside the iPhone.
QCOM stock, however, crashed back to earth as sales of that leading brand sagged and the company encountered various problems in China.
Qualcomm stock disappointed shareholders over the last year, as it fell from $75 at its peak to a low of $42 earlier this year. However, shares rebounded to $56 recently, and QCOM shares are up 7% in Thursday’s early morning trading following a strong earnings report.
Has Qualcomm stock made it through the worst of the storm? Or should investors use this recent rally to lighten their exposure to the firm?
Qualcomm Stock Pros
Leading Internet of Things Position: According to a study by LexInnova, Qualcomm has the most IoT-related patents of any firm, coming with more than 700. Intel Corporation (NASDAQ:INTC) is a close second, holding 688 such patents. After those two, no other competitor weighs in with more than 351. And according to LexInnova, Qualcomm’s patents in the area are significantly more valuable than Intel’s.
LexInnova breaks it down farther, judging some patents to be “high-value.” Competitors are more likely to infringe these high-value patents. In this category, Qualcomm has more than twice as many high-value IoT patents as any other competitor. Thus, Qualcomm’s high marks here indicate that they have a strong patent library that enables many important functions for future IoT applications.
Huge Earnings Beat: Qualcomm surprised the market with a strong earnings report Wednesday. The company had a massive quarter on both the top and bottom line. Revenues had been expected to be more or less flat year-over-year. Instead, non-GAAP revenues grew by 3.6% compared to the same quarter last year. QCOM stock struggled with falling revenues over the past year. The sudden, and unexpected, swing to renewed gains will win favor with the market.
On the bottom line, earnings also delivered: Q3 came in at $1.16, fully 19 cents ahead of expectations. In past quarters, QCOM stock fell as investors grew more troubled by the state of the company’s key Apple Inc. (NASDAQ:AAPL) relationship. However, even as Qualcomm lost a bit of space in the iPhone, it picked up a good deal more share in lower-end smartphones. While this is bad for margins, the increased volume of shipments more than carried the day, at least for this quarter.
Strong Dividend Yield: QCOM stock offers one of the best yields out of the technology sector. The company yields 3.8% at present. Out of large tech firms ($50 billion market cap or greater), only Cisco Systems, Inc. (NASDAQ:CSCO), International Business Machines Corp. (NYSE:IBM), and Qualcomm yield more than 3%. Out of those, QCOM stock is currently the highest yielding.
In addition to that, Qualcomm’s dividend grows both quickly and consistently. Since 2003, the firm has raised the dividend for Qualcomm stock each and every year.
Over the past five years, the dividend has risen at a compounded 21% rate annually. Investors who bought the stock five years ago earn a more than 9% yield on cost.
Qualcomm Stock Cons
Licensing Business Faces Headwinds: About 40% of Qualcomm’s business relies on revenues it receives from licensing out its intellectual property to third parties. This is a valuable, but vulnerable, revenue stream since the company is subject to numerous lawsuits and other hassles that come with defending intellectual property.
In the previous quarter, Qualcomm’s licensing revenue dropped double-digits compared to that same quarter in 2015. Also, it’s worth remembering that Qualcomm revenues generally fall as average revenue per unit “ARPU” for smartphones decline. This is generally offset by increasing volume of sales, but a maturing smartphone market weakens this trend over time.
Additionally, in 2015, the Chinese government fined Qualcomm almost one billion dollars for supposedly abusing its market position and engaging in monopolistic activity. This leaves the firm in a difficult position. If Qualcomm is very successful in licensing, it runs afoul with the anti-trust regulators. And if it doesn’t vigorously defend its intellectual property, a horde of imitators and lower-end competition are ready to profit off Qualcomm’s research and pre-existing chipsets and designs.
Smartphone Growth Tapped Out: Gartner’s recent smartphone market forecast makes for harrowing reading if you are bullish on stocks in the sector. They say flatly that the era of 10%-plus growth for smartphones “has come to an end.” The company sees only 7% smartphone growth in 2016 globally, with virtually none of that in either China or North America. The only real growth markets left are the emerging ones. And the margins that Qualcomm and other players can make on low-end smartphones simply aren’t that inspiring.
Gartner further notes that lifespans for smartphones are rising, as users no longer rush to upgrade to the latest offering. With incremental rather than exponential technological gains at this point, as they put it, the upgrade cycle lost steam.
According to Qualcomm’s regulatory filings, total worldwide cellular connections stand at 7.4 billion. That figure is equal to the world’s population. And the lion’s share of those connections have already transitioned to at least low-end smartphones.
QCOM stock can deliver good returns if the smartphone market plateaus at current levels and the company remains a dominant player; but its best growth days are behind it.
Heavy China Exposure: Qualcomm stock is heavily exposed to China. In a variety of ways, China plays a large role in determining Qualcomm’s fate. The prospects for iPhone and other smartphone sales depend to a great degree on China. Many of Qualcomm’s employees reside in China, and the company has paid fines related to bribery of Chinese officials. Much of the supply chain also involves the country.
Now with the Chinese economy weakening and the yuan falling, this could put the pinch of QCOM stock in coming quarters. The company also gets just under half its revenues from China. Sales could fall, and currency exchange could harm the company. China is a country of great opportunity for tech firms. But it also comes with above-average risk. Qualcomm stock is quite exposed to changing tides there.
Verdict
QCOM stock should be a reasonable long-term performer. It is, admittedly, suffering from real and enduring problems with the slowdown in the smartphone market and licensing concerns.
However, its position in IoT gives it a strong future growth opportunity. Shares probably have few more quarters of volatility ahead, but buyers here will likely be pleased with longer-term results.
If Wednesday’s earnings results are any guide, QCOM stock turned the corner and is now in a more bullish trajectory.
At the time of this writing, Ian Bezek owned shares in Qualcomm, Intel, IBM, and Cisco. You can reach him on Twitter at @irbezek.
