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For investors looking for a tech company with strong fundamentals that is currently on the verge of a breakthrough, Qualcomm Inc. (QCOM) is a company worth further investigation.

Qualcomm, Inc. develops digital communication technology called CDMA (Code Division Multiple Access), and owns intellectual property applicable to products that implement any version of CDMA including patents, patent applications and trade secrets.

In the section below, I will analyze aspects of Qualcomm's past performance. From this evaluation, we will be able to see how Qualcomm has fared over the past four years regarding their profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $3.247 billion
  • Net income 2011 = $4.260 billion
  • Net income 2012 = $6.109 billion
  • Net income 2013 = $6.853 billion

Over the past four years, Qualcomm's net profits have increased from $3.247 billion in 2010, to $6.853 billion in 2013, which represents a 111.06% increase.

  • Operating income 2010 = $3.283 billion
  • Operating income 2011 = $5.026 billion
  • Operating income 2012 = $5.682 million
  • Operating income 2013 = $7.230 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past four years, Qualcomm's operating income has increased from $3.283 billion to $7.230 billion in 2013. This represents an increase of 120.23%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $3.247 billion
    • Net income 2011 = $4.260 billion
    • Net income 2012 = $6.109 billion
    • Net income 2013 = $6.853 billion
  • Total asset growth

    • Total assets 2010 = $30.572 billion.
    • Total assets 2011 = $36.422 billion.
    • Total assets 2012 = $43.012 billion.
    • Total assets 2013 = $45.516 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 10.62%.
    • Return on assets 2011 = 11.70%
    • Return on assets 2012 = 14.20%.
    • Return on assets 2013 = 15.06%.

Over the past four years, Qualcomm's ROA has increased from 10.62% in 2010 to 15.06% in 2013. This indicates that the company is making more on its assets than it did in a few years ago.

QCOM Return on Assets (<a href='http://seekingalpha.com/symbol/ttm' title='Tata Motors Limited'>TTM</a>) Chart

QCOM Return on Assets (TTM) data by YCharts

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $30.572 billion
    • Total assets 2011 = $36.422 billion
    • Total assets 2012 = $43.012 billion
    • Total assets 2013 = $45.516 billion
    • Equals an increase of $14.944 billion
  • Total liabilities

    • Total liabilities 2010 = $9.714 million
    • Total liabilities 2011 = $9.471 billion
    • Total liabilities 2012 = $9.489 billion
    • Total liabilities 2013 = $9.428 billion
    • Equals an decrease of $286 million

Over the past four years, Qualcomm's total assets have increased by $14.944 billion, while the total liabilities have decreased by $286 million. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of the liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $12.133 billion
    • Current assets 2011 = $14.293 billion
    • Current assets 2012 = $15.645 billion
    • Current assets 2013 = $19.555 billion
  • Current liabilities

    • Current liabilities 2010 = $5.468 billion
    • Current liabilities 2011 = $5.289 billion
    • Current liabilities 2012 = $5.302 billion
    • Current liabilities 2013 = $5.213 billion
  • Current Ratio
  • Current ratio 2010 = 2.22
  • Current ratio 2011 = 2.70
  • Current ratio 2012 = 2.95
  • Current ratio 2013 = 3.75

Over the past four years, Qualcomm's current ratio has increased significantly. As the current ratio is currently well above 1, this indicates that Qualcomm would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 1.643 billion
  • 2011 shares outstanding = 1.658 billion
  • 2012 shares outstanding = 1.700 billion
  • Current shares outstanding = 1.689 billion

QCOM Shares Outstanding Chart

QCOM Shares Outstanding data by YCharts

Over the past four years, the number of company shares has increased. The company shares have increased from 1.643 billion to 1.689 billion and increase of 2.8%.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $7.474 billion / $10.991 billion = 68.00%.
  • Gross margin 2011 = $10.080 billion / $14.957 billion = 67.39%.
  • Gross margin 2012 = $12.025 billion / $19.121 billion = 62.89%.
  • Gross margin 2013 = $15.046 billion / $24.866 billion = 60.50%.

QCOM Gross Profit Margin (Quarterly) Chart

QCOM Gross Profit Margin (Quarterly) data by YCharts

Over the past four years, Qualcomm's gross margin have been decreasing. The ratio has decreased from 68.00% in 2010 to 60.50% in 2013. Qualcomm's gross margins have been declining due to an increasing mix of emerging market sales and the growing competition from rivals such as Nvidia (NVDA) and Broadcom (BRCM). These are suppliers for predominantly lower-end mobile phones, but Qualcomm still dominates the high end market.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $10.991 billion
    • Revenue 2011 = $14.957 billion
    • Revenue 2012 = $19.121 billion
    • Revenue 2013 = $24.866 billion
    • Equals an increase of 126.24%
  • Total Asset growth

    • Total assets 2010 = $30.572 billion
    • Total assets 2011 = $36.422 billion
    • Total assets 2012 = $43.012 billion
    • Total assets 2013 = $45.516 billion
    • Equals an increase of 48.89%.

Over the last four years revenue growth has increased by 126.24% while the assets have increased by 48.89%. This is an indication that the company, from a percentage point of view, has been more efficient at generating revenue with its assets.

Based on the information above we can see that Qualcomm fundamentally has had a strong few years. Some of the strengths include the ROA which indicates that Qualcomm's is generating more income from assets than it did four years ago. The TL/A ratio is also showing strength as the company's assets are much faster than the company's liabilities. A notable strength is that the company's liabilities are decreasing. Over the past four years the liabilities have decreased by $286 million. A very notable blemish that the analysis has revealed is that the gross margin has declined significantly. Over the past four years the gross margin has fallen from 68.00% to 60.60%.

New CEO and China

Effective March 4, 2014, Qualcomm will be introducing a new chief executive officer. One of CEO Steve Mollenkopf's most important challenges and biggest opportunities will be cleaning up issues on the Chinese front. As the company is expecting strong growth of the 3G and 3G/4G multimode devices around the world particularly in China, having a solid footing in this market is essential.

Currently, Qualcomm has components in many products including Apple's (AAPL) iPhones and the Samsung (OTC:SSNLF) Galaxy's but for the most part they are absent from devices in the China Mobile Ltd.'s (CHL) network. They are absent due to the Chinese carrier deploying a system called TD-SCDMA.

TD-SCDMA shares many characteristics of CDMA but the Chinese government claimed the technology is different enough that its companies don't need to pay royalties.

The TD-SCDMA carrier is the largest in China and globally but it hasn't been able to lead the 3G transition in the same manner as it has in 2G.

CDMA has proven to be the best technology for delivering data to phones. With successful adoption by carriers such as Verizon (VZ) in the U.S., KDDI Corp in Japan and Korea, Qualcomm now needs China to follow suit.

In working with China Mobile, CEO Steve Mollenkopf is trying to clean-up a setbacks Qualcomm suffered when phone systems were upgraded to 3G.

The Chinese market is essential for the continued growth of Qualcomm. As the company "irons" out details regarding growth in the Chinese market this should have a profound effect on the potential earnings moving forward.

Currently, Qualcomm is anticipating "double-digit compound annual growth rates for both revenues and earnings per share over the next five years." Capitalizing on the massive Chinese market is essential for the company to realize this estimation.

Valuations

In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and forward P/E ratios to estimate the current value of each share.

I believe using the Discounted Cash Flow valuation model for Qualcomm to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.

(click to enlarge)

Even though there are variations in calculating this formula, this model is based off of a terminal value of $123.705B and a WACC of 6.86%. The terminal value $123.705B is based off of the company trading at 15X EBITDA. At this point in the market, I believe 15x EBITDA to be a fair valuation. Using the valuations above, I have concluded Qualcomm's current value to be $76.57 per share.

Looking forward to 2014, I will use Qualcomm's forward P/E ratios with estimated earnings to find the value. Currently, Qualcomm has a forward P/E of 13.16 and FY 2016 earnings projected at $5.44. These two metrics lead to a target price of $71.59.

As of January 3rd, Qualcomm's stock was trading at $72.59 - Using the Discount Cash Flow Formula, this indicates the stock is currently undervalued by 5.48%. Looking forward to 2014, If I calculate a valuation using a forward P/E of 13.16 ratios this indicates a valuation $71.59, this indicates the stock is overvalued by 1.39%.

Strategy

At this point in the market, I believe Qualcomm's stock is close to fairly valued. Having stated that, as it looks like we are in the middle of a moderate correction, if you added a position here and slowly added on dips, I believe the investor will be rewarded. Currently, I believe there is further upside to equity markets as major world economies are either recovering or on the verge of recovering. As interest rates continue to remain near zero this should favor equities.

Conclusion

Since July, Qualcomm's stock has participated in a strong bull run. With anticipated growth overseas, particularly in China, I believe any dip is a buying opportunity. As estimates indicate that Qualcomm will produce an EPS of $5.44 in 2016 combine that with a forward P/E ratio of 13.16 this produces a 2014 target of $$71.59. At current levels using the Discount Cash Flow Formula, I believe the stock is currently slightly undervalued but if the Qualcomm can capitalize on the Chinese market there is no reason to believe that double-digit compound annual growth rates for both revenues and earnings per share over the next five years is out of the question.

Source: Qualcomm: Trading At Fair Value With A Long-Term Buy