Qualcomm: 3 Reasons To Buy Now

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About: QUALCOMM Incorporated (QCOM)
by: Mauro Solis
Summary

The trade war has impacted Qualcomm in the short term, but the long term prospects are intact.

When the other half of the world population gets internet, they will connect via smartphones powered by Qualcomm.

5G rollout will increase the competitive advantage of the company and improve its short and long term prospects.

Qualcomm (QCOM) is expected to perform admirably next year, and the market estimates it will be performing enviously in the following years.

Three reasons make Qualcomm a great stock to get now. The revenue of the company will grow stronger as the other half of the population gets internet and 5G rolls out in developed countries. The trade war has impacted the price significantly, and the stock is trading at a very fair price.

Investing in the company presents an ideal risk-reward proposition with lovely downside and excellent upside potential, for a reasonable price.

Three Reasons to Buy

In more than one occasion I have said that there are three big changes coming to the technology world. AI, IoT and the other half of the population getting Internet. People that do not have internet access yet will almost certainly get access exclusively form their smartphones. As telecommunication plans and services get cheaper and are accessible, a growing number of users will transition from traditional mobiles to smartphones. The tendency will greatly increase the demand for the low-end chips that Qualcomm produces.

In a previous article, I estimated that by 2025, there could be 2 billion more internet users thanks to Kai OS.

Source: Statista

As for the high-end of Qualcomm's portfolio, as the market transitions from 4g into 5G, there will be an increase in Smartphones sold.

As the video above shows, 5G is aimed to be a monumental change in the telecommunications industry and all major Android Manufacturers will launch a 5G phone in 2020.

Let me walk you through the dynamics of 5G rollouts. 5G network rollouts are progressing at a much faster rate when compared to 4G. We expect over 20 operators to launch 5G service and over 20 OEMs to have 5G devices in the first 12 months after the first commercial launch. This compares to four operators and three OEMs with the launch of 4G with the major difference being that China is launching 5G in the first year.

- Steve Mollenkopf - CEO 2019 Q3 Earnings call

As Steve Mollenkopf mentions, the transition into 5G seems to be going even faster than the previous 4G shift, which bodes well for Qualcomm.

Valuation

The past few years revenue growth has oscillated from -6.8% and 2% and the tendency has been growing. The assessment considers an average revenue growth of 12.2% compared to the past average of -3.7%. Looking at gross margin, it has ranged between 57.1% and 60.6% and the tendency has been decreasing. The estimate considers an average gross margin of 55.2% compared to the past average of 59.2%. R&D as a percentage of revenue has been between 20.6% and 24.7%, and the trend has been up. The estimate considers an average R&D as a percentage of revenue of 19% compared to the past average of 22.7%. With the above considerations, we have the following chart

Source: Author´s Charts

These approximations are in line with the market expectations for Qualcomm in the next couple of years, as the image below shows.

Source: Seeking Alpha

I like to use Peter Lynch's ratio when valuing a stock. This method uses the ratio between the expected earnings growth plus dividends and the P/E of the stock to determine its fair value. A stock that has a 1:1 ratio is reasonably priced. The higher the number, the more underpriced the stock is.

Source: Author´s Charts

This valuation does not take into account the assets and liabilities of the company. The growth considered in the assessment is the average yearly growth of the next years, taking as reference non-GAAP earnings. While the valuation considers the dividend to estimate the fair price, it is not taken into account for the average yearly return.

With this valuation, arguably, the stock is at worst overvalued by 23% and at best undervalued by 38%. So the stock is fairly valued

Source: Author´s Charts

Building an adjusted Beta Pert risk profile for the current fair price of the stock, we can calculate the risk profile for purchasing the stock now.

The risk profile shows there is a 37.46% probability that Qualcomm will trade at a lower price than it is today. Considering the potential downside, upside and the likelihood of each, the statistical value of the opportunity of investing now, is of 4.4%

Constructing an adjusted Beta Pert risk profile for the long-term prospects of the stock, we can calculate the risk profile for the company

Source: Author´s Charts

The risk profile shows there is an 8% probability that Qualcomm will ever trade at a lower price than it is today. Considering the potential downside, upside and the likelihood of each, the statistical value of the opportunity of investing now, is of 17.4%

Adding to that the dividends that the company offers, the downside and upside become even more attractive.

Conclusions

The company has a lot of things going its way; the downside potential is a dream come true, the level of risk is secure, and the expected performance for the foreseeable future is robust.

Sure, the company is not without problems, the trade war has inflicted some pain, and the decrease in gross margin could become a concern, but the long term prospects are good enough to justify the risk, and the current price is more than fair.

There is no way to tell how big the trade war is going to be and how long it is going to last. But however big or scary it gets, it is unlikely that it can impact the megatrends that have been developing in the technology world and although the ride could be treacherous, in the long run, Qualcomm will come out on top.

In the last 60 years, we have seen the cold war, the 2008 market crash, the fall of the Soviet Union and none stopped or slowed down Moore´s Law, and the Trade War will not stop Qualcomm.

If there is anything in this article, you agree or disagree with or would like me to expand further on; I would sincerely appreciate you leaving a comment. I will address it as soon as possible.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in QCOM over 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.