>> In my humble opinion I think the fair value of the stock is around
>>$18 to $20/shr. And I can almost guarantee you within the next
>>3 to 4 months, sometime after the quarter earning report you will
>>see the stock at that price.
Like you, I have been following this stock for the last year or so, and I also like to buy value for the long term. Unlike you, however, I finally decided that I had waited long enough and took a decent position - because the stock is so cheap now. While I never know how the market will behave in the short term, it seems to me that it is extremely unlikely that the stock will dive to $18 to $20/shr over the next 3 to 4 months, particularly since the most likely direction is certainly up from here.
You refer to QCOM's high PE ratio as an indication of its being expensive. In my view, QCOM doesn't yet even have a PE ratio, and to calculate a trailing PE ratio gives a false impression of the value of the company. The EPS over the last four years was 25, 28, 52, 30 cents, which gives the impression that the company was beginning to make serious earnings in FY 95 (up almost double), but disappointed in FY 96, leaving a very high trailing PE of about 130. At first glance the stock does look expensive, very expensive.
But look deeper. The operating margins for these years was 7.3%, 8.5%, 5.3% and -0.9% (after adjusting for extraordinary expenses). These aren't operating margins of a real business. In particular, it makes no sense whatsoever to talk about QCOM's existing trailing PE of 130 being high or low. It doesn't exist. The company made no money in FY 1996. The 30 cents EPS was from non-operating income. None of this would be confusing if QCOM was a biotech company, not yet making any significant income. The confusion stems from the fact that QCOM is making a lot of revenue, and increasing it at a faster and faster pace - but not yet making profits.
So, to value QCOM properly, one needs to normalize the earnings (or better, future earnings) by estimating (1) how fast revenues will continue growing and (2) how much of the revenues could be pass through as earnings from operations. The rest is easy.
Due to the announced roll-outs over the last few months, and Globalstar's obvious success (military use through Loral, China signed on, great CDMA technology) providing huge infrastructure development contracts, there can be little doubt but what revenues will continue to expand rapidly - roughly doubling at least over the next couple of years.
The near-term risk is in regard to how fast the operating expenditures can normalize to what is appropriate for a company in this sector blessed with their CDMA franchise. By far the biggest concern is the speed with which manufacturing costs of handsets will normalize to a profitable level. And admittedly, if the manufacturing costs don't begin to show improvement, the stock will continue to lag far below its intrinsic value.
An average sizable company in the telecommunication equipment business can expect to make 10% net profit. The large and growing royalty income, coupled with its CDMA franchise, gives it a leg up on developing related hardware (ASICs, infrastructure, handsets, remote data appliances) and software (messaging, data applications, voice recognition). Technology companies that have the luxury of operating with this type of franchise are so rare you can count them practically on one hand. What it ultimately translates into is that these special companies get to charge higher prices than others, and they get to profit more. This means that QCOM should be making 15% or more net profit within three or four years. FY 97 should see the beginning of this progression, with operating margin around 12% and net profit over 7%. By FY 98, these figures should be at least 15% and 10%, respectively. A year after that and net profit could easily attain 15% of about $4 billion revenue, or $600 million. Even with significant share growth, this would amount to $6 or $7 EPS, and carry a deserved PE of 50 or 60.
Consequently, I see the stock as a 10 bagger within three to five years - assuming manufacturing costs get in line. On the downside, there is only the short-term possibility that the stock could dive temporarily for some silly reason like a disappointing quarter, caused by delays containing costs or being able to accrue royalty income - but not because of its "high" trailing PE ratio. The most likely possibility is that something good happens relative to expected numbers, and the stock gaps up - never to return to these cheap prices. (I think this because it seems to me that every part of the business is now in production, with all parts starting to contribute to revenues and profit. I would even expect that the large increases in the Globalstar development contracts will off-load much the excessive R&D.)
Technically, it seems that the stock has been consolidating broadly between $37 and $54 for a year and a half. While I am not a technical analyst, it seems clear to me that the stock must either break-down below $30, or try again to break out on the upside, and ultimately succeed. The disciplined technical analyst will not prejudge these possibilities, and will stay on the side lines until one or the other is proven. Unfortunately, the proof of an upside breakout will not occur before the stock exceeds the mid-fifties on high volume, meaning the technical analyst will give away $15 or more dollars per share waiting for confirmation.
I think the stock will break out to the upside on good earnings expectations (probably preceding good earnings reports), so I don't have any compunction about buying the stock today. If I am wrong in my timing, I will have to wait slightly longer, and probably buy more while I wait.
Allen |
