Qualcomm (NASDAQ:QCOM) is now set to produce significantly higher earnings next year from gains in its 5G chip sales. But QCOM stock still does not completely reflect this and is too cheap. This is despite having risen dramatically this year.
For example, in the past six months since April 23, QCOM stock is up 74.5%. This was after its March quarter earnings (its fiscal Q2) were out. It was clear that 5G smartphones using their chip technology were going to be launched later in the year. In fact, I wrote about this in my previous article on Feb. 26 and argued that the stock was unbelievably cheap.
Moreover, the stock has since risen more than 46% in the year-to-date to $128.88 as of Oct. 23. This is despite its drop during the novel coronavirus market break in Q1 2020.
But that does not mean that the stock cannot keep on rising. In fact, as we will see, QCOM stock is still incredibly cheap and probably worth at least 20% more than today.
Financial Outlook for Qualcomm
Qualcomm will report its September quarter (its fiscal Q4) earnings on Nov. 5. Analysts expect to see at least $1.18 in earnings per share (EPS), and as much as $1.67 in the December quarter.
Therefore that puts QCOM stock on a run-rate annual EPS of between $4.72 to $6.68. Therefore, let’s assume its annual earnings power is $5.70 in EPS annually. This means that at today’s price of $128.88 QCOM stock is trading for just 22.6 times earnings. That is incredibly cheap.
Don’t forget as well that Qualcomm typically beats its earnings projections. This means that my estimate of its 2021 earnings power could be too cheap. But first, consider this.
Analysts polled by Seeking Alpha estimate 2021 fiscal year EPS of $6.46 per share. The Yahoo Finance analyst survey shows the same average forecast. These forecasts are much higher than my “earnings power” method above. It means that on a one-year out basis, QCOM stock is even cheaper at just 20 times forward EPS.
And don’t forget that with higher earnings, Qualcomm’s free cash flow (FCF) will explode. Right now the company makes an incredibly high 30% FCF margin on its revenue as of its June quarter. For example, FCF for the quarter was $1.454 billion on $4.893 billion in revenue.
But more importantly, its FCF works out to be 172% of its net income. This is what analysts call “conversion.” Net income for the quarter was $845 million, but FCF was $1.454 billion. It converted over 172% of net income into usable free cash flow.
5G Set to Explode
The main growth driver for the company is the continuing uptake of 5G smartphones and related devices using Qualcomm’s 5G technology. For example, Qualcomm and Apple settled a long-running lawsuit last year and now Apple is using Qualcomm’s 5G technology in its phones.
As a recent article in Seeking Alpha from Khaveen Investments points out, Qualcomm is seeking to gain permission from the Commerce Department to allow Huawei to use its 5G technology. As Huawei is the largest operator using 5G technology, they want to gain market share.
It may seem odd that despite the administration’s ban on Huawei using U.S. technology, apparently, other companies have gained permission to sell to Huawei. Qualcomm wants to be able to do so as well, especially since it recently resolved its lawsuit against Huawei. Khaveen Investments indicates in their article that Qualcomm’s global market share in 5G technology will rise significantly if it secures the Huawei deal.
Other analysts are also warming up to QCOM stock, despite its recent gains. For example, JPMorgan recently called it a “win for Qualcomm” for Apple to use its mmWave antenna module technology.
In addition, Citi analyst Christopher Danely raised his target price to $132 from $108. He sees the company’s earnings driven by 5G to grow by 43% through 2021.
Qualcomm’s President Cristiano Amon was recently quoted as saying he wanted to make 5G accessible to all smartphone users. The company recently released a 4-chip version of its Snapdragon chipset that will allow 5G on cheaper phones priced $125 to $250.
What to Do With QCOM Stock
TipRanks.com reports that the average analyst price target for QCOM stock is $133.33, or 3.45% higher than today. However, I have shown that the forward P/E ratio for the stock today is only 20 times earnings. This is significantly below both its average P/E and the P/E of its peers.
For example, Morningstar reports that Qualcomm’s average P/E multiple over the past five years is 24.78. Applying that to next year’s forward earnings forecast of $6.46 produces a target price of $160.07 per share. That represents a potential gain of 24% above today’s price.
Moreover, its peer average P/E is much higher. Seeking Alpha has a page that shows its peer average forward P/E ratios. The average of four of its peers is 34 times forward earnings. That implies a target price of $219.64, or 70.4% above today’s price.
The average of these two methods of valuing QCOM stock is $189.86, or 47% above today’s price. That makes the stock a very solid buy at today’s price.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Mark Hake runs the Total Yield Value Guide which you can review here.
