Shares of Qualcomm (QCOM) have returned 14.42% over the past 12 months. At $59.04 per share, the stock is trading at around the mid-point of the 52-week trading band between $49.78 and $68.87. I recommended QCOM in May at a price around $58. Subsequently, the stock rose to about $65 and is now experiencing a pullback. I believe investors should take this opportunity to load up shares given that the stock is trading at attractive valuations and also offers a decent dividend yield at 1.7%. In this article, I will elaborate the analysis that supports my view.
QCOM is trading at a cheap valuation based on the company's financial performance relative to its peers (see table below). Let's look at some financial comparisons between QCOM and the company's two most comparable companies - Texas Instruments (TXN) and Broadcom (BRCM). Analysts in average predict QCOM's revenue, EBITDA, and EPS to grow at 2-year CAGRs of 20.5%, 21.1%, and 19.4% over the current and next fiscal years. The growth estimates are substantially higher than the peer averages of 3.1%, 11.6%, and -5.8%. However, QCOM's EBITDA margin is forecasted to expand by 0.4% over the same period, slightly lower than the peer average at 1.4%. On the profit side, all of QCOM's margin and capital return metrics are largely higher than the measures of TXN and BRCM, indicating a robust profitability. The company assumes a low leverage as reflected by its lower debt to capitalization and debt to EBITDA ratios. In terms of liquidity, QCOM has the highest free cash flow margin at 23.4%, compared to the peer average of 18.9%. Due to the strong profitability and the low level of debt, the company was able to maintain a healthy interest coverage rate. Both QCOM's current and quick ratios are significantly above the par, reflecting a very liquid balance sheet.
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To summarize the financial comparisons, QCOM's financials are superior to those of the two comparable peers in almost every aspect, and as such, the stock should command a solid valuation premium over the peer average level. Nevertheless, the current stock valuations at 10.4x forward EV/EBITDA and 15.2x forward P/E represent an average valuation premium of only 3.5% over the peer-average trading multiples (see table above), suggesting that QCOM may not be fully valued based on the company's potentials.
Comparing QCOM's valuation to that of the market, the stock's forward P/E multiple is currently trading at a 12% premium over the same valuation multiple of the S&P 500 index (see chart below). Given that QCOM's estimated long-term earnings growth rate of 13.2% is significantly higher than the average estimate of 7.9% for the S&P 500 companies, a larger premium (i.e. 15% to 20%) would easily be warranted. It should also be noted that QCOM's trailing EV/EBITDA multiples is trending fairly close to its 10-year low (see chart below), despite the fact that the company's growth and profitability remain robust.
From a dividend growth perspective, the stock's downside appears to be well protected. The current dividend yield at 1.7% is safely backed by QCOM's sound dividend policy and ample free cash flow. Since FY2003, the annual dividend per share has been raised by a 9-year CAGR of 32% from $0.1 in FY2003 to $1.0 in FY2012E, and the annual dividend growth rate has stabilized at above 10% over the past few years (see chart below). Additionally, the annual dividend payment historically only represented a small portion of the annual free cash flow, suggesting that there is an ample slack to maintain the current pace of the dividend growth (see chart below).
To have a sense of the stock's downside protection, let's look at a 5-year dividend yield chart shown below. Apparently, the yield stayed within the range between 1.4% and 1.8% most of the time since late 2010, despite the fact that QCOM has raised the quarterly dividend twice since then. The strong demand from income-oriented investors who need a technology exposure may partially explain the pattern. As such, assuming a target yield range between 1.4% and 1.8%, and supposing that the current annualized dividend per share at $1.0 would be raised by 15% to $1.2 in March 2013 (QCOM typically announces a dividend hike in March), the base-case scenario would imply a stock value range between $64 and $82, representing an average upside of 24%.
Bottom line, in the light of the cheap valuations and the expected solid dividend growth, investors would enjoy a solid margin of safety by investing in QCOM. Therefore, I strongly recommend buying the shares now.
Comparable analysis table is created by author, all other charts are sourced from Capital IQ, and all financial data is sourced from Morningstar and Capital IQ.