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Should You Buy Qualcomm for Its 4% Dividend Yield?

Leo Sun, The Motley Fool

Qualcomm (NASDAQ: QCOM) shed more than 10% of its market value this year after it avoided a takeover bid by Broadcom, lost its own takeover bid for NXP, and faced fresh regulatory probes and lawsuits from OEMs -- most notably Apple (NASDAQ: AAPL) and Huawei -- which claimed that its wireless licensing fees were too high.

Qualcomm tried to offset some of the damage with a $30 billion buyback plan, but the chipmaker's fourth-quarter report didn't boost investor confidence. Its revenue fell 2% annually to $5.8 billion, while its non-GAAP net income declined 7% to $1.3 billion. Its non-GAAP EPS, buoyed by buybacks, fell 2%.

A transparent view of a smartphone.

Image source: Getty Images.

For the first quarter, Qualcomm expects its revenue to drop 13%-26% annually due to an 18%-26% drop in its MSM chip shipments and unresolved issues at its licensing business, but for its non-GAAP EPS -- again lifted by buybacks -- to rise 7%-17%. That guidance indicates that Qualcomm's headaches won't end anytime soon.

However, Qualcomm's stock also looks cheap at 12 times forward earnings, and it pays a forward dividend yield of 3.9%. The bulls will likely argue that low valuation and high dividend should buoy Qualcomm's stock as it sorts through its legal challenges, gears up for the launch of 5G networks, diversifies away from its mobile business, and continues repurchasing shares to lift its earnings and tighten up its valuations. But is Qualcomm's yield worth all the drama?

How sustainable is Qualcomm's dividend?

Qualcomm has hiked its dividend annually for over a decade. In fiscal 2018, it spent $3.5 billion on dividends and $22.6 billion on buybacks. However, Qualcomm's dividend payments also used up over 100% of its earnings and free cash flow over the past year. In fact, the chipmaker was unprofitable on a GAAP basis in 2018, reporting a loss of $3.32 per share as it paid out $2.38 in dividends.

However, those payout ratios were distorted by taxes, stock-based compensation expenses, and other one-time charges, which were excluded from its non-GAAP earnings. On a non-GAAP basis, Qualcomm's EPS of $3.69 easily covered its dividend. Furthermore, its dividends, buybacks, and debt payments were mainly paid out with the cash which it previously set aside for its failed takeover of NXP.

As a result, Qualcomm's cash and equivalents dropped from $38.6 billion to $12.1 billion between the fourth quarters of 2017 and 2018. Simply put, Qualcomm shouldn't have any trouble maintaining its streak of dividend growth as long as it moves past its one-time expenses and turns around its core business.

But can Qualcomm fix its core business?

Unfortunately, Qualcomm is struggling with two main problems. First, the chipmaking (QCT) unit -- which generates most of its revenue -- faces a saturated smartphone market filled with cheaper rivals like MediaTek and first-party chipmakers like Huawei. Apple's recent decision to replace Qualcomm's modems in its new iPhones with Intel's (NASDAQ: INTC) exacerbated the pain.

A patent stamp.

Image source: Getty Images.

Second, its licensing (QTL) unit -- which traditionally generates most of its profits -- is under fire from regulators and OEMs, which claim that its cut (up to 5% of the wholesale price of a phone) is too high. Rival chipmakers also claim that Qualcomm used anti-competitive strategies to dominate the mobile chipset market.

Qualcomm believes that it can resolve its patent disputes with new agreements, grow both its QCT and QTL revenues with the 5G ramp-up, and keep buying back shares to soften the blow of its declining net income. Qualcomm might try to buy another chipmaker again, but it will likely use buybacks and dividends to placate shareholders instead -- which won't offset its lack of revenue growth forever.

There's also no evidence that Qualcomm's headwinds will wane anytime soon. It was already fined in China, South Korea, and Europe; US regulators recently ruled that Qualcomm must license its technology to rivals like Intel; and Reuters recently reported that Apple wasn't ready to settle its escalating legal battles against Qualcomm "at any level." Apple will also reportedly wait until 2020 to launch a 5G iPhone powered by an Intel modem instead of launching one earlier with Qualcomm's chips.

Look for other high yielders instead

Qualcomm's downside could be limited, but there are plenty of other stocks that pay higher dividends with less drama. Qualcomm should focus more on solving its long-term issues instead of inflating its earnings and giving its CEO an undeserved raise. Therefore, investors should move on and seek out other income stocks instead.

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Leo Sun owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Broadcom Ltd and NXP Semiconductors. The Motley Fool has a disclosure policy.