Thursday, February 11, 2010

Qualcomm – Stock Analysis for Dividend Growth Portfolio

Qualcomm manufactures and markets digital wireless telecommunications products and services based on its code division multiple access (CDMA) technology and other wireless communication technologies. QCOM is neither a dividend aristocrat nor a dividend achiever. QCOM has started showing some dividend growth trends in last five years. The latest dividend increase was in January 2010. My objective here is to understand if QCOM has any potential to be a dividend investment and fair value pricing for buy.

Trend Analysis

This section looks at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts is shown in image below.

  • Revenue: In general, after 2001, QCOM has stable and consistent growth in revenue. The average revenue growth for last 10 years is 12.3% (with 15% standard deviation).
  • Cash Flows: Relatively increasing trend for operating cash flow and free cash flow. In the last ten years, the company’s operating cash flows are consistently higher than net income. The concern I have is the free cash flow is more or less similar to net income. There is very little room for flexibility in allocating cash for dividends.
  • EPS from continuing operation: In general, the EPS also has an increasing trend since year 2001 with average growth rate as 60%. Most of that growth is coming in 2003 and 2004. Since 2005, the EPS growth rate has been approximately 15%. The earnings dropped in 2009.
  • Dividends per share: Dividends per share are consistently growing for the last 5 years.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.71. This is a medium risk category as per my 3-point risk scale. The reduced EPS and reduced operating margins in 2009 makes it medium risk to dividends.

Quality of Dividends

This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

  • Dividend growth rate: The average dividend growth of 16% is more than average EPS (13.4%) growth rate. However, when we look at last three years alone, the dividend growth and EPS growth are very similar (closer to 21% for both).
  • Duration of dividend growth: Dividends have continuously grown for the last 6 years.
  • 4 year rolling dividend growth rate for past ten years: No
  • Payout factor: In the past 5 years, it has been consistently less than 35%. But 2009 payout factor was 70%.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 1.8%; and (b) MMA yield is 2.2%. Considering the last 3 year average dividend growth rate of 16.3%, the stocks dividend cash flow at the end of 10 years is 2.5 times MMA income.

Fair Value Calculation
This section determines what price I should pay to buy a given stock

  • Net present value (NPV) price based on 15 year DCF: $54.17
  • Average high yield price calculated based on past 10 years: $32.5
  • Pricing based on past 10 year relative price-to-earnings ratio. $56.0
  • Pricing based on price-to-earnings ratio of 12: $18.7
  • Graham number: $18.2 The range of fair value is calculated as $27.4 to $37.8.

Qualitative Analysis

The strength of QCOM’s business is its ownership of CDMA technology, royalty-based cash flow of more than USD 1 billion dollars, most of the competitors are struggling, and a strong technology-driven roadmap. QCOM is on path to become Google of wireless communication chipset. Contrarily, the concerns I have with QCOM is it operates in a cyclic industry and never ending legal battles.

  • This quantitative analysis shows that, in last 5 years QCOM has had significant growth in revenue. It continues to maintain 60%+ gross margins. Generally, its operating margins at higher than 30%, but it dropped to 21% in 2009. Its EPS has high volatility.
  • Notwithstanding the higher operating cash flow, the recession driven slow down has affected its EPS.
  • Assuming that the corporation’s existing trends in profitability and growth continue ‘as is’, the low payout factor will allow the corporation to continue to maintain (if not raise) the dividends.


The stocks current risk-to-dividend number is 1.71 (medium risk category). In addition, the dividend cash flow is 2.5 times the MMA income based on average dividend growth rate of 16%. Moving forward, I expect dividend growth rate to slow down (10% to 12% range). In that case, the price will have to drop down to $25.80 for dividend income to be twice MMA income. This pricing of $25.80 is also very close to my low range of my fair value. I like QCOM’s technologically-driven dominant market position and its medium risk-to-dividends. However, for a potentially good dividend investment, I would wait for its price to get closer to my low end (i.e. $27) of the fair value range.

Full Disclosure: No position at the time of this writing.

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