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Possible troubles overseas makes Qualcomm less attractive

Tuesday, November 18th, 2014

A couple of weeks ago I got a call on my radio show about Qualcomm, which had just taken a small beating in the stock market after reporting earnings. The numbers, as I reviewed them, looked pretty good but, as I always say, you have to understand the business. There were some items that Qualcomm brought out that could be a problem for the company in the future.


If you are going to invest in Qualcomm (Nasdaq: QCOM), you need a thorough understanding of the following two items.

First, Qualcomm has some troubles in China, where its technology licensing business, QLT, is under investigation. The problem could lead to fines and perhaps reduced royalty fees, which would hurt the company's earnings.

While Qualcomm has nearly $18 billion in cash and $14 billion in long-term investments, it could easily cover the fine; I'd be more worried about future reduced fee income. The size of the fines has been estimated at about $1 billion.

Second, there were also some rumblings of possible problems in Europe. So as I share the numbers with you, keep in mind the numbers look good, but investors must understand potential problems.

As always, a good place to start is the valuation ratio, which tells investors what they're paying for in earnings, sales, book value and cash flow of the company. We have a good start for Qualcomm with a price earnings ratio of 15.8, well below the industry average of 22.4.

Price to sales, however, doesn't look so good, with Qualcomm at 4.4, double the industry at 2.1. Price-to-book value favors Qualcomm at 3.6 times, compared with the industry at 5.0 times. Price to cash flow is on the higher side for Qualcomm at 13.3, above the industry at 11.0.

Qualcomm pays a 2.4 percent dividend, which is better than the industry average of 1.7 percent. Also, Qualcomm uses only 25.4 percent of its earnings to pay that out, compared to the industry average, which uses 37.3 percent to pay out the lower dividend.

Qualcomm's sales seem to be slowing down, growing at a rate of 6.5 percent over the past 12 months, which does not meet the higher rate of the industry average at 9.9 percent over the past 12 months. Earnings-per-share over the past 12 months grew at a rate of 12.6 percent, which is respectable but far below the industry average of 37.5 percent.

One has to love Qualcomm's balance sheet, starting with a current ratio of 3.7, far more liquid than the current industry average ratio of 2.3. The debt-to-equity for the industry average is 37.3 percent; Qualcomm has zero debt on the balance sheet.

I have to ask myself, what if they took advantage of the low-interest rates, borrowed some cash and used the money to buy back stock? I hope someone at Qualcomm reads this article and considers doing that; I believe it would dramatically help the share price.

Return on equity was 20 percent for the past 12 months for Qualcomm, compared with the industry average at 14.4 percent. The net profit margin for the company is very good at 28.4 percent, roughly three times the industry average of 9.3. I know that if Qualcomm is forced to cut the royalty fees it would hurt the profit margin, but there is a good amount of room to reduce the profit margin and Qualcomm would still be profitable.

Looking at the efficiency of Qualcomm, I see the receivable turnover is very good at 11.8 times during the past 12 months, beating the industry average of 8.2. Inventory turnover also favors Qualcomm at 7.6 times during the past 12 months, well ahead of the industry turnover of 4.8 times.

There are 28 analysts giving estimates for earnings going out to September 2016; their average is $5.74. Using a forward PE multiple of 16.5, the target sell price is $94.71. If Qualcomm is trading under $70 a share, this will yield investors a return of about 36 percent, looking out to September 2016.

Analysts have cut this earnings estimate of $6.01 from just a week ago to the current $5.74, a reduction of about 4½ in Qualcomm's future earnings. The PEG ratio is on the low side at 1.12, which is positive because the lower the PEG ratio, the less investors are paying for the company.

So, while I like how Qualcomm has pulled back in price, I'm not ready to invest my money just yet in this company. However, I think Qualcomm is worth watching at these levels.

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