It has been a fabulous year for shares of wireless technology giant Qualcomm (NASDAQ:QCOM). Year-to-date, Qualcomm has rallied more than 54% — marking its best annual return since 2004 — to all-time highs as investors cheer management’s aggressive efforts to capitalize on the company’s huge 5G opportunity in the 2020s.
From where I sit, the huge year-to-date rally in the stock makes a ton of sense. 5G is going to change everything and the financial implications are going to be huge.
Qualcomm is at the center of the 5G movement, especially now that they have brought Apple (NASDAQ:APPL) back on as a customer. The company’s revenues and profits will march meaningful higher over the next several years. This big profit growth will drive equally big gains in Qualcomm stock.
I get all that. That’s why I’ve been bullish on Qualcomm for most of 2019. See here, here, and here.
But, I’m less bullish today on the stock than I have been in previous months for one very simple reason: all the good stuff seems fully priced into it today. That is, although 5G will power a bright a future for Qualcomm, overly optimistic investors have bid up the stock to valuation levels that already account for this bright future … and then some.
Qualcomm Has a Bright Future
There’s no denying the fact that 5G will power a bright future for Qualcomm over the next three-to-five years.
5G has received a ton of hype, and with good reason. It’s going to change everything about the internet communications sector. That is, the 4G to 5G evolution doesn’t just mean faster and better connectivity, it means that all of tomorrow’s most important technologies will finally work at scale.
Self-driving. Seamless automotive internet connectivity. Cloud gaming. Global 4K streaming. These next-gen technologies don’t work without the decreases in latency and increases in traffic capacity, network efficiency, and connection density that come with 5G. From this perspective, 5G isn’t just a step up. It’s a step in an entirely new direction, which will unlock a new (and much bigger) era of internet communications.
Qualcomm is the backbone of this 5G powered future. Long story short, they are the big dog in the wireless communications sector, and there really isn’t much competition. Thus, if a company is going to launch a 5G device, they are going to launch it with Qualcomm.
Because of this, the 5G boom over the next three-to-five years will power significant revenue growth, margin expansion, and profit growth at Qualcomm, the sum of which should drive its stock higher in the long run.
The Stock is Fully Valued
Although Qualcomm has a bright future, Qualcomm stock appears fully valued at the current moment.
Combining the company’s recent Analyst Day presentation with my research into the financial implications of the 5G boom, I think that Qualcomm reasonably projects as a low double-digit revenue grower and low teens profit grower into 2025.
That projection breaks down simply. The number of connected devices in the world is expected to grow at a near 20% clip into 2025. The smartphone market projects to grow at a low single-digit pace into 2025. Qualcomm’s non-licensing revenue growth rate will run somewhere in between those two rates, at around 10-15% per year. Management is calling for licensing revenue to be roughly flat over the next several years. That combination ultimately makes Qualcomm seem like a sustainable low double-digit revenue grower.
Meanwhile, gross margins should move higher thanks to favorable demand drivers, and opex rates should move lower as big revenue growth drives positive operating leverage. Margins should therefore add a sizable boost to profit growth. Based on management’s long-term margin targets, it seems reasonable that low double-digit revenue growth turns into low teens profit growth.
Realistically, then, the 5G boom could drive Qualcomm’s earnings per share towards $8 by fiscal 2025.
Based on an exit multiple of 15-times forward earnings (which is average for the communications equipment sector) and a 7% annual discount rate (to account for the 3% yield), that equates to a 2020 price target of about $90. That’s where Qualcomm stock is trading hands today, and we haven’t even entered 2020 yet.
Bottom Line
Qualcomm has a bright future through the 5G boom. But a lot of 5G upside is already priced into the stock today. As such, valuation challenges could cause the red-hot 2019 rally to cool in 2020.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
