On Feb. 5, San Diego-based Qualcomm (NASDAQ:QCOM), the leading chipmaker, released mixed Q1 FY20 earnings. The report warned Qualcomm stock investors of the potential adverse effects of the coronavirus from China. Following the results, the stock has been volatile with a downward bias. Year to date, the share price is down about 6%.
Coupled with the potential for a broader market decline, the uncertainty surrounding chip stocks amid the global coronavirus outbreak will likely continue to weigh on the shares in March.
But thanks to its diversified revenue stream and the strength of its technological offerings, I believe the stock still belongs in a long-term growth portfolio. Thus long-term investors could regard any further drop in the stock’s price as an opportunity to buy into the company.
Let’s take a closer look.
Qualcomm’s Recent Earnings Were Mixed
Qualcomm is the largest maker of chips for smartphones and wireless modems. Its chipsets account for more than two-thirds of its total revenue. The next main source of revenue comes from mobile phone royalties and licensing. Its patent-licensing division collects royalties from 3G and 4G technologies that the chip giant helped invent. Its portfolio of wireless patents is the largest globally.
Q1 revenues for the mobile chip maker came in at $5.08 billion for the quarter, beating analyst estimates of $4.86 billion. It earned an adjusted 99 cents a share in its fiscal first quarter ended Dec. 29. Analysts had expected earnings of 86 cents a share. On a year-over-year basis, earnings fell 17.5%, while revenue rose 5%.
Management reported earnings in three segments:
- QCT (Qualcomm CDMA Technologies): semiconductor business, about 71% of revenue
- QTL (Qualcomm Technology Licensing): licensing business, about 28% of revenue
- QSI (Qualcomm Strategic Initiatives): makes strategic investments, less than 1% of revenue
Although QCT provides Qualcomm with most of the revenue through sale of mobile chipsets, wireless patents provide most of the profits. In other words, the higher-margin licensing unit supports the growth of its lower-margin chipmaking business.
Analysts noted that stronger sales of smartphones bolstered its technology licensing business. However, the group warned that it was now seeing a decrease in orders of chips from China-based customers due to the outbreak of the new virus.
Chief financial officer Akash Palkhiwala said the group now expects “significant uncertainty around the impact from the coronavirus on handset demand and supply chain.”
Since Feb. 5, many investors have become increasingly concerned on the short-term performance of the stock and the share price has reflected that worry. In January 2020, Qualcomm stock hit a 52-week high of $96.17. Now it’s hovering around $85.
Qualcomm Stock and the 5G Technology
Many of our regular readers would be familiar how the Street expects Qualcomm to play a dominant and early role in 5G, replicating its success with 3G and 4G mobile networks.
The company is likely to provide a significant part of the intellectual property that will be used to develop 5G communications standards. And, as I’ve pointed out in the past, “the fifth-generation infrastructure market is expected to grow at a compound annual growth rate (CAGR) of 30% in the first half of this new decade.”
Other companies that manufacture or use chips need to obtain a license from Qualcomm. Several of the largest customers include Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Samsung (OTCMKTS:SSNLF).
Now handsets will have new chipsets that are 5G-compatible. With the smartphone upgrade cycle that is underway, many users will be purchasing a 5G-compatible device.
In the quarterly press release of Feb. 5, CEO Steve Mollenkopf highlighted that the group’s strong fiscal-first-quarter financial performance showed how it was beginning to realize the benefits from the ramp of 5G.
Thus, if history can act as a guide, Qualcomm will continue to innovate. And its success in earlier 3G and 4G mobile networks will help it increase the bottom line.
Other Catalysts to Consider
Unless you are a momentum-based short-term trader, taking a long-term view with an emphasis on fundamental analysis and valuation metrics is important in equity analysis.
Qualcomm stock currently trades at a forward price-to-earnings ratio of 20, which many investors may regard as a good ratio for a tech giant. In comparison, the forward P/E ratios of Advanced Micro Devices (NASDAQ:AMD), Nvidia (NASDAQ:NVDA) and Texas Instruments (NASDAQ:TXN) are about 45, 37 and 23, respectively.
Also the stock’s 2.9% dividend yield and the company’s generous stock repurchase program are likely to act as support in case the stock declines further in the coming weeks. It would be important to remember that the chip giant has regularly increased its dividend in the past.
Therefore, investors who also pay attention to creating a passive income stream are likely to see any further drop in the share price as an opportunity to buy into QCOM stock. And that would act as support for the share price.
China s Important for Technology Stocks
With 1.4 billion residents, China is the most populous country globally. After the U.S., it is also the world’s second-biggest economy by GDP. Over the past decade China’s influence on global commerce and especially technology has grown exponentially.
Tech giants constantly emphasize the importance of the country for their supply chains as well as sales. For example, semiconductor sales to China represent more than half the global chip demand. And China accounts for about a quarter of the smartphone demand worldwide. Qualcomm, which currently has 14 offices in the country, gets about half of its revenue from China.
Apple management has also recently warned about the economic effects created by the most recent viral outbreak. And broader markets have become increasingly nervous that amid this health scare, business confidence may fall and capital spending may decline in the coming months.
As the global demand for chips will likely fall during the quarter, the increased uncertainty may rock many stocks, including Qualcomm stock, even more. In recent months, Qualcomm’s management has further highlighted the importance of China for the company, especially in terms of developments around 5G.
The wireless chipmaker is already in a royalty dispute with the controversial Chinese tech giant Huawei, which is on a U.S. trade blacklist. The trade war conflict between the two countries that dominated the headlines in most of 2018 and 2019 as well as the difficulty surrounding Huawei had already adversely affected the company’s revenue in 2019. China is quite lucrative market for U.S. tech companies.
In March, we are likely to get a better understanding of the economic effect of the outbreak. Meanwhile, investors may decide to sell tech stocks first and ask questions later.
The Bottom Line on Qualcomm
Globally, the positive wave of 5G is just beginning. And Qualcomm is likely to be a leader with robust earnings growth. It will continue to sell chipsets and modems as well as profit from licensing intellectual property to other companies.
However, I would not advocate bottom picking if the stock weakens and becomes wobbly in the near-term. Shares are up over 60% in the past year. It would not be surprising if investors decide to take money off the table now. Yet, I find the stock to be a compelling buy candidate, especially between $80 and $85. And in two to three years, I’d expect Qualcomm stock to trade over $100.
If you already own shares of Qualcomm, depending on your risk/return profile, you may decide to patiently ride the current wave. You could also reinvest the dividends and compound your returns.
Alternatively, if you are experienced in hedging with options, you may decide to initiate a covered call position. For example, a March 20 ATM or slightly ITM covered call would offer some downside protection. It would also enable you to participate in an up move should the markets decide the selling will be short lived.
Fear and greed are the two emotions that affect short-term moves in broader markets and especially in momentum-based tech stocks like Qualcomm. Therefore, I’d urge you to exercise caution if you are a short-term trader. But if your horizon is long-term, then you may want to take advantage of the current volatility to buy into Qualcomm shares.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.