Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Qualcomm QCOM, in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess Qualcomm's financial condition. The information that I am using for this article comes from Qualcomm's website here. Note that this article is not a comprehensive review as to whether Qualcomm should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
Qualcomm focuses on delivering products and services based on its advanced wireless broadband technology. They sell integrated circuits that are used in numerous mobile devices and wireless networks. They produce and sell integrated circuits that are used in wired devices, like personal computers and televisions. The company produces software that enables and enhances mobile commerce. Companies in the transportation and government sectors use Qualcomm's products and services to wirelessly manage their assets and workforce. The company also licenses some of its intellectual property, such as patent rights that are used in the production and sale of certain wireless products.
Qualcomm has a market capitalization of $113B and has recorded just over $20B in sales over the last 12 months.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
As of Dec. 31, 2012, Qualcomm had $13.3B in cash and short-term investments, which can be easily converted into cash. This is a lot of cash for a company that has a market cap of $113B. This means that the company is trading for less than nine times its cash position, which can be very attractive for value-oriented investors. Over the last 12 months, Qualcomm paid out $1.65B in dividends. This dividend is well-supported by its trailing 12-month free cash flow of $5.07B. The company recently announced a 40% increase in the quarterly dividend, from 25 cents per share to 35 cents.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
Qualcomm had a total of $1.65B in net receivables on its balance sheet, which represents 8.09% of its trailing 12-month sales of $20.4B. For fiscal 2012, which ended on Sept. 30, 2012, 7.64% of its sales were booked as receivables, while that percentage was at 6.62% for fiscal 2011.
While this percentage is creeping higher, it is still fairly consistent and relatively small. So, at this point, I don't see much to worry about when it comes to receivables.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of Qualcomm is 3.41, which is excellent.
Property, Plant, and Equipment
Every company, regardless of the industry in which it operates, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant, and equipment, as companies that constantly have to upgrade and change its facilities to keep up with competition may be at a bit of a disadvantage.
However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors. Right now, Qualcomm has $2.88B worth of property, plant, and equipment on its balance sheet. This figure is inline with the $2.85B that the company reported 3 months before, and slightly above the $2.41B that they reported at the end of fiscal 2011. Of these assets, 31% is in machinery and equipment. 24% of the assets are in computer equipment and software, while 23% is in buildings.
Given the consistency of Qualcomm's position in this area, as well as the fact that property, plant, and equipment account for less than 7% of the company's total assets, I don't see any concerns for Qualcomm in this area.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case by case basis, as good companies are rarely purchased at or below book value.
Qualcomm has $3.93B worth of goodwill on its most recent balance sheet, which is inline with the $3.92B worth of goodwill that it reported 3 months prior, and the $3.43B that was reported at the end of fiscal 2011.
Overall, goodwill accounts for less than 9% of Qualcomm's total assets of $44.8B. Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed at the beginning of this section. Since Qualcomm is well below this threshold, I don't see much to be concerned about here.
Intangible assets that are listed on the balance sheet include items such as licensed technology, patents, brand names, copyrights, and trademarks that have been purchased from someone else. They are listed on the balance sheet at their fair market values. Internally-developed intangible assets do not go on the balance sheet in order to keep companies from artificially inflating their net worth by slapping any old fantasy valuation onto their assets. Many intangible assets like patents have finite lives, over which their values are amortized. This amortization goes as annual subtractions from assets on the balance sheet and as charges to the income statement. If the company that you are researching has intangible assets, with finite lives, that represent a very large part of its total asset base, then you need to be aware that with time, those assets are going to go away, resulting in a reduction in net worth, which may result in a reduction in share price, unless those intangible assets are replaced with other assets.
Qualcomm currently has $2.83B worth of intangible assets on its balance sheet. This is inline with the $2.94B that the company reported 3 months before and the $3.10B that was reported at the end of fiscal 2011. Of these intangible assets, 95% are technology-based. All of these assets have finite lives, meaning that they are subject to amortization over the next few years.
While the amortization of $2.83B worth of intangible assets over the next several years isn't a good thing for the balance sheet, I am not too concerned about it going forward, as these assets account for less than 7% of the company's total assets.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For Qualcomm, the return on assets would be $6.99B in core earnings over the last 12 months, divided by $44.8B in total assets. This gives a return on assets for the trailing twelve months of 15.6%, which is very good in absolute terms. I also calculated Qualcomm's returns on assets over fiscal years 2012, 2011, and 2010 for comparative purposes. This can be seen in the table below.
Table 1: Returns On Assets From Qualcomm
The above table shows that Qualcomm's returns on assets have been very consistent over the last few years, and have actually been growing a bit. The reason for this is the company's earnings growing slightly faster than the company's asset base. Earnings growth that keeps up with asset growth is something that we want to see, as it shows that management is doing a good job with the assets that are at its disposal.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
This is not a concern at all for Qualcomm, as they do not have any short-term debt. That's right, zero.
Long-term debt is debt that is due more than a year from now. However, an excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Guess what! Qualcomm doesn't have any long-term debt either. They haven't carried any long-term debt for at least the last three years. This suggests that the company may have some competitive advantages that keep Qualcomm from having to borrow money in order to finance the company's operations. This is great!
The debt-to-equity ratio is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8.
Now, before I go any further here, I just mentioned that Qualcomm is not currently carrying any short or long-term debt. By the calculations of many, the debt-to-equity ratio for Qualcomm would be zero. However, there are other liabilities that the company is carrying, such as accounts payable and deferred revenue. My method of calculating the debt-to-equity ratio takes these items into account as well.
Let's see how Qualcomm stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For Qualcomm, it looks like this: $9.49B / $35.3B = 0.27
Right now, Qualcomm looks to be in pretty good shape, as it sports a low debt-to-equity ratio. The table below shows how this figure has changed over the last three years.
Table 2: Debt-To-Equity Ratios Of Qualcomm
As can be seen in Table 2, Qualcomm has done a fantastic job at keeping its liabilities in check. The debt-to-equity ratio has not only been consistently good, but has even been improving.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholder Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. However, Qualcomm is not one of these companies.
So, the return on equity for Qualcomm is as follows:
$6.99B / $35.3B = 19.8%
This appears to be a pretty solid return on equity. In the table below, you can see how the return on equity has fared over the past three years.
Table 3: Returns On Equity At Qualcomm
These are very consistent returns on equity, and very strong as well, considering that Qualcomm hasn't juiced these figures by taking on large amounts of debt. The consistency comes from the company's earnings and equity position growing at the same rate.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Below, you can see how the retained earnings have fared at Qualcomm.
Table 4: Retained Earnings At Qualcomm
From the above table, you can see that Qualcomm has an impressive retained earnings figure of $22.2B. However, what's even more impressive is the growth in retained earnings. Over the past three years, retained earnings at Qualcomm have grown at a cumulative rate of nearly 67%. This is impressive by any metric. This shows that the company is growing its earnings and its net worth. However, the trend is starting to moderate, as the company has been increasing its dividend payout, which isn't necessarily a bad thing.
After reviewing the most recent balance sheet, it can be concluded that there is a lot to like about Qualcomm's financial condition. For starters, the company has a relatively large cash position when compared to its market capitalization. The company has enough current assets on hand in order to meet its short-term obligations in the event that its operations encounter an unlikely disruption. Qualcomm sports very strong and consistent returns on assets and equity, showing that management is doing a good job with the assets at its disposal. Goodwill has been kept in check, at less than 9% of the company's assets, suggesting that Qualcomm has not been overpaying for acquisitions lately. And, above all else, the company carries no short or long-term debt!
While this is not a comprehensive review as to whether Qualcomm should be bought or sold, it can certainly be said that Qualcomm is in EXCELLENT financial condition.
To learn more about how I analyze financial statements, please visit my new website at this link. It's a new site that I created just for fun, as well as for the purpose of helping others make good financial decisions.
Thanks for reading and I look forward to your comments!