Wireless technology giant Qualcomm (NASDAQ:QCOM) has had a great 2019. Year-to-date, QCOM stock is up more than 50% — marking its best annual return since 2004 — as investors have cheered management’s aggressive efforts to capitalize on the huge forthcoming 5G opportunity.
When 5G does come, it will change everything. This isn’t just another smartphone coverage upgrade cycle. It’s a coverage upgrade cycle which will enable an entire new era of internet communication, characterized not just by smartphones, but by a broad array of internet-enabled devices across the automotive, manufacturing, healthcare, retail, energy, logistics, and gaming industries.
Qualcomm has proven itself as the undisputed leader in 5G tech. As such, as every industry across the globe invests big in 5G tech over the next several years, they will be pouring money into the Qualcomm ecosystem. Revenues will power higher, margins will expand as big revenue growth converges on cost-cutting measures, and profit growth will be robust.
Investors have reasoned that this robust profit growth will drive huge gains in QCOM stock. So, they’ve aggressively bid up Qualcomm stock in 2019, to the tune of a 50% year-to-date gain.
There’s just one problem with this otherwise very compelling bull thesis: valuation. That is, at current levels, QCOM stock is already priced for robust profit growth. This reality could ultimately put the red-hot, 5G-inspired rally in QCOM stock on hold for the time being.
QCOM Has a Huge Opportunity in 5G
The big picture reality here is that Qualcomm has a huge opportunity to leverage the 5G movement over the next several years to drive robust profit growth, the likes of which this company hasn’t seen in a long time.
There has been a lot of hype surrounding 5G over the past few months. 5G is going to change everything at a time when the world needs everything to change. Sure, it’s easy to look at the stats — 5G has a 10-times decrease in latency relative to 4G, 100-times more traffic capacity, 100-times greater network efficiency, and a 10-times increase in connection density — and say: so what? The “so what” is that everything in the world needs these improvements.
Self-driving, seamless automotive internet connectivity, and cloud gaming doesn’t work without 5G. A lot of things don’t work without 5G, and because of this, 5G truly is going to change the world. It’s going to enable a new (and much bigger) era of internet communications.
Thanks to decades of leadership experience in the wireless communications sector, a rich portfolio of patents, and an unparalleled volume of resources, Qualcomm is the undisputed 5G leader. QCOM will grow side-by-side with the 5G space. That is, as industries far and wide from retail (think point-of-sale smart checkout systems) and logistics (think of mile-by-mile package tracking tech) invest in 5G tech, they will likely be pouring money into Qualcomm.
The result? Qualcomm’s revenues will roar higher over the next several years. So will profit margins, since Qualcomm is simultaneously cost-cutting next to this big revenue growth. Big revenue growth plus margin expansion equals bigger profit growth. That’s a winning recipe for QCOM stock.
Qualcomm Stock Is Fully Priced
Long term, I love Qualcomm stock. But, in the near term, the valuation gives me pause.
Consider this. According to the company’s recent Analyst Day presentation, Qualcomm’s mobile business projects to grow at a 10%-plus pace over the next several years. The Adjacent Platforms business (Internet-of-Things, Automotive, and Compute) projects to grow at a high single-digit pace. The Licensing business projects to remain largely flat. Putting all that together, Qualcomm realistically projects as a ~10% growth business into 2025.
Operating margins are expected to expand gradually with cost-cutting measures, higher average selling prices, and favorable demand trends. Making modestly aggressive assumptions on the pace of this expansion, ~10% revenue growth should turn into 13-15% profit growth. Assuming so, that pegs 2025 earnings per share at about $8.
Based on a communications equipment sector-average 15-times forward earnings multiple, that equates to a fiscal 2024 price target for QCOM stock of $120. Discounted back by 7% per year (to account for the 3% yield), that equates to a 2019 price target of about $85 — so, up at $90, Qualcomm stock seems slightly overvalued.
Bottom Line on QCOM Stock
Qualcomm has a tremendous 5G opportunity in front of it. Unfortunately, in the intermediate term, most of that opportunity is already priced into QCOM stock, meaning that near-term upside potential will be limited by valuation friction.
The investment implication? Hit the sidelines. Wait for QCOM stock to cool down. Buy the dip towards $80.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
