Reasons Why Qualcomm May Be Good For Your Portfolio

May.16.13 | About: Qualcomm Inc. (QCOM)

Qualcomm (NASDAQ:QCOM) stock recently dropped to a three-month low following the release of its third quarter 2013 earnings estimate. Does this mean that investors should start dumping this tech stock from their portfolios and start looking for ones with better prospects?

Why The Stock Price Fell

Qualcomm stock price dropped as much as 6.4% in the wake of an earnings estimate that was markedly lower than what analysts were expecting. In New York trading following the announcement, QCOM fell 5.8% to $62.15 and touched the $61.79 level. The San Diego-based semiconductor seller said that its net income per share for the quarter ending in June would be 80 cents to 88 cents, while analysts had projected that earnings for the period would reach 88 cents. QCOM results are significant because they are seen as a proxy for overall growth in the handset industry. The company has a dominant position in the industry, since its technology and chips are used in the majority of advanced mobile phone models.

In addition analysts expressed concern that Qualcomm's licensing income might decline due to lower average selling prices for handsets, due to market pressures as an increasing number of sales came from markets where buyers preferred cheaper models. The company predicted that for 2013, the average selling price per phone would be $224, lower than earlier predictions that it might be as much as $226 per handset. This shift towards lower-end phones is hurting Qualcomm's profitability. While revenues from its chip division increased 28% in the second quarter from the same quarter 2012, operating margin for this business fell to 17% from 26% in the previous quarter. Operating margin is used to measure a company's operating efficiency and pricing strategy and is computed by dividing operating income by net sales. This ratio gives analysts an estimate of how much the company earns for every dollar of sales it generates (before taxes and interest).

Net income for the second quarter (ending March 31) declined 16% to $1.87 billion from $2.23 billion in the same period last year. Sales, however, increased to $6.12 billion, or a 24% increase from a year earlier.

Why Qualcomm is Still a Buy

Given analysts' pessimism towards Qualcomm, why should investors continue to hold on to the stock? Simply, the company's dividends are set to continue growing in the years ahead. The company recently increased its dividends to $1.40 per share from the previous $1 per share. The reason for this is that despite the weakness in the company's CDMA technology division due to consumers' shift to the lower end of the market, it is still earning handsomely from licensing its patents, a business that is still going strong. Since its chips and technology are present in many 3G and 4G-enabled phones, Qualcomm earns royalties of 3% to 4% for every unit sold of these handsets. Hence, although its chip division earned a pre-tax income of just $681 million, its licensing business earned a handsome $1.8 billion before taxes.

The bulk of Qualcomm's revenues come from baseband chips, which connect mobile phones to cellular networks. The chips are sold to some of the biggest handset makers in the world, including Apple (NASDAQ:AAPL) and Korean electronics giant Samsung (OTC:SSNLF). It also earns most of its profit from licensing its code division multiple access technology, which is a standard that is used in phone systems and handsets. Qualcomm also earns royalties from phones that are compatible with networks using the CDMA standard but don't use its chips.

Since licensing is not capital-intensive, most of the division's earnings before tax simply end up being reflected on its balance sheet. Its latest financial statements show that the company has $30 billion in cash and cash equivalents. It also seems that the company would rather distribute this income to its stockholders though dividends rather than using it for buying back its stock, as shown by the fact that the company did not buy back any shares during the past quarter.

The Bottom Line

Qualcomm is still relatively affordable after its recent stock price drop, making it a bargain that no investor should pass up. The latest stock price is currently still at $65.32 per share. And since revenue growth is seen to continue in the foreseeable future, Qualcomm is a perfect long-term stock to hold in your portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.