The other day I wrote an article describing a method to identify companies that have a competitive advantage based on their financial reports. One of the requests I received after writing that article was to provide a similar analysis for Qualcomm (QCOM).
Today I will be reviewing the different financial statements of Qualcomm to determine if the company has a competitive advantage in the marketplace. Since this is a quick analysis, I will only be looking at the last five years of data, which I will take from ycharts.com. I will not be going into detail describing the method, so if you are unfamiliar or need clarity on any of the terms below, please see the original article.
For those unfamiliar with Qualcomm, the company started with just seven individuals in 1985. Today the company operates multiple business units and is a world leader in providing wireless technology services. According to iSuppli, Qualcomm has just over 4.3% of the semiconductor market share by revenue, making it the third largest in the industry, after Intel (INTC) and Samsung (GM:SSNLF) at 15.7% and 10.1%, respectively. For more information about Qualcomm, please visit its webpage.
SGA : Gross Profit
R&D Expense : Gross Profit
Depreciation Expense : Gross Profit
EPS, basic ($USD/share)
In looking at the income sheet, while Qualcomm only meets six out of the seven criteria, it is clear to me that the company has a competitive advantage. For starters, the gross margin is consistently over 40% with a 68% five-year average. Next, the SGA expense to gross profit ratio is well below 35% and there no depreciation or interest expense. In addition, the net margins are well north of 20% and the EPS has been consistently growing. All of these are extremely strong indicators that the company has a competitive advantage.
The only concern is the R&D expense relative to gross profit. The percentage is consistent, but is higher than the 10% or less I like to see. It indicates to me that the company is dependent on innovation for long-term success and that the competitive advantage that Qualcomm does have is coming from Qualcomm's ability to innovate (not very surprising for a tech company).
Cash & Short Term Investments ($B)
Liabilities : Stockholder Equity + Treasury Stock
Retained Earnings ($B)
The balance sheet of Qualcomm further supports my belief that the company has a competitive advantage. While I did not compare the ratio of receivables to gross sales with the rest of the industry, the other 5 metrics suggest the company has a competitive advantage.
The cash and retained earnings accounts have grown over the past five years with average growth rates of 17.9% and 15.2%, respectively, without putting debt or preferred stock on the balance sheet and the ratio of liabilities to stockholder equity plus treasury stock is also well below the 80% I recommend for manufacturing companies.
Statement of Cash Flows
Capital Expenditures : Gross Profit
The statement of cash flows was consistent with the other two financial statements in concluding that Qualcomm has a competitive advantage. The ratio of capital expenditures to gross profit was well below the 25% ratio I recommend, indicating the company does not have to reinvest much earnings into the business to continue operations and grow.
After analyzing the financial statements for Qualcomm over the last five years, I would conclude the company has a significant competitive advantage over the rest of its competitors.
My one watch out is that this competitive advantage is driven by Qualcomm's ability to innovate. Innovation can be a fickle thing, one day you have, and the next day you don't. In the case of Qualcomm, I might be comfortable taking the risk and watching the stock for any developments that indicate Qualcomm is losing its edge since the other expenses are so low relative to gross sales, but I would not recommend investing in Qualcomm if you are a passive investor.
Finally, I would not recommend investing in Qualcomm until developing a deeper understanding of the business and conducting a proper analysis of the company's management and current market valuation. Only after reviewing these points and contrasting it to this analysis would I consider investing in Qualcomm.