Stock Pick of the Week: Qualcomm (QCOM)

International Investing
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The wireless and mobile market is one of the fastest growing markets in the entire world. From cell phone access, 4G connectivity, or even data usage, all signs point to this market being adopted and developed worldwide. Wouldn’t you like to be able to get in on this growing market? The best way to do so is through exposure to our stock pick of the week, Qualcomm (QCOM).

Chip Leader Around the World

Qualcomm makes digital communication products, mainly in the form of mobile chipsets. Numerous cell phone manufacturers as well as other devices that connect to 3G/4G wireless networks, such as notebooks and tablets, use these chipsets. As the use of these devices grows, particularly in markets such as China and India, Qualcomm is poised to grow as well. The global processor market reached $5.2 billion in revenue in 2Q14 as reported by Strategy Analytics. Qualcomm accounted for 68% of this revenue, easily surpassing competitors MediaTek, Spreadtrum, Marvell, and Intel.

Add in the continued growth of the “internet of everything,” in which many new types of devices will require wireless connectivity, and it’s easy to see why Qualcomm has great growth potential going forward.

Leader in Profitability as Well

Over the past decade, Qualcomm has grown after-tax profits (NOPAT) by 18% compounded annually. In its 2014 10-K, Qualcomm reported total revenue increases of 7% over 2013, bolstered by a 20% year over year increase in mobile station modem integrated circuits for wireless devices.

On top of its impressive profit growth, Qualcomm is increasingly more efficient with the capital in its business. In 2014, Qualcomm generated a return on invested capital (ROIC) of 55%, up from an impressive 30% in 2010. This increase shows that Qualcomm is generating higher returns on all money flowing into the business.

Qualcomm is also a cash machine, generating over $17 billion in free cash flow over the past four years, with $6.6 billion alone in 2014. This free cash gives Qualcomm many options when looking to create future growth opportunities.

One Worry to Note

It would be impossible to look at Qualcomm without mentioning the ongoing investigation in China over antitrust issues. Qualcomm continues to be investigated by Chinese authorities over whether Qualcomm’s business is a monopoly and stamps out domestic Chinese competition.

This investigation threatens to seriously hamper Qualcomm’s profits and growth potential in China. A ruling against Qualcomm would likely mean not only fines, but also decreased licensing fees from Chinese phone manufacturers. Nothing suggests an exit from China, rather a potential shift in how Qualcomm must run operations in the country.

China Mobile, the world largest wireless carrier, is transitioning its network to the LTE standard. Qualcomm already provides these chips to phone manufacturers, and the inclusion of these phones on China Mobile’s network would create great growth opportunities.

Undervalued Despite China Investigation

In spite of the concern about China operations, Qualcomm’s impressive and sustained profit growth leaves it undervalued at current prices. At ~$71/share, Qualcomm has a price to economic book value (PEBV) ratio of 1.0. This ratio implies the market expects Qualcomm to never grow its NOPAT for the remaining life of the company.

If we assume the worst in China, and give Qualcomm credit for only 7% NOPAT growth (less than half its 10 year average) compounded annually for the next 10 years, the stock is worth $99/share today –– a 39% upside.

If we give Qualcomm credit for higher growth, assuming the China issue gets resolved quickly and does little to hamper business, the potential is even greater. If Qualcomm can grow NOPAT by 11% compounded annually for the next 10 years, the stock is worth $126/share today –– a 77% upside.

The beauty of buying a strong company that is the leader in a rapidly growing market is that your portfolio can experience the same type of growth. Finding a company in that market that is undervalued like Qualcomm is an even better situation. Add Qualcomm to your portfolio today.

Kyle Guske II contributed to this report.

Disclosure: David Trainer owns QCOM. David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

Photo Credit: Kevin Baird (Flickr)

 

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