Monday, June 13, 2011

Is Qualcomm good for your portfolio?

Qualcomm (NASDAQ: QCOM) -- a designer and builder of digital wireless telecommunications products and services -- is one of the few public companies to enjoy a successful father to son transition. Founder Irwin Jacobs' son, CEO Paul Jacobs, envisions a future of sensor networks (SN) -- seeking to implement an idea I wrote about in 2005. But does this mean Qualcomm stock will make you richer?

In 2005, I wrote about Sensor Networks (SNs) as a possible technology in which companies might invest to boost their productivity. Back in 2003, Wal-Mart Stores Inc. (NYSE: WMT) was trying to create a kind of SN through an initiative announced to require its top 100 suppliers to install Radio Frequency Identification (RFID), by Jan. 1, 2005. RFID tags are small, 25-cent components including a chip, antenna and product information that Wal-Mart could track through in-store and in-warehouse RFID signal-reading machines.

While Wal-Mart didn't meet its January 1 deadline, the benefits--reduced supply chain costs, shelves stocked with what consumers want and less of the rest, as well as diminished theft--make the Wal-Mart initiative an SN test case. And it was still working out the kinks by 2009.

SNs may also help with building automation, industrial monitoring and perimeter security. Berkeley, Calif.-based Dust Networks' SmartMesh technology deploys sensors that collect and transmit physical data for such industries. But developers must address big challenges before SNs become the "next big thing."

RFID and SNs create huge amounts of data, generated by tracking many items' locations over time, explains Jeannie Ross, senior researcher at MIT's Center for Information Systems Research (CISR). In 2005, Ross told me that she believes that SN developers must find the right application and the analytical tools to sift nuggets of insight from torrents of data. A technically feasible application might not make business sense. For instance, a retailer could put an RFID tag on a $1 tube of toothpaste to signal the retailer when the consumer emptied the tube, but this would probably not profit the retailer.

Before SN data can pass across corporate perimeters, settlement systems must be developed, argued Kim Perdikou, Juniper Networks' (NASDAQ: JNPR) CIO. For example, if an SN data packet passes through a local telephone company, a cable broadband provider and a private wireless carrier, the participants must agree how to hand off the data and allocate and charge the relevant costs.

Furthermore, SN developers must protect data privacy, noted Bill Dally, Stanford University Computer Science chair. For motorists in traffic, real-time data on the position and speed of vehicles ahead of them on the highway could be more useful than radio traffic reports. But unless an "anonymizer" protects motorists' identities, people worried about their privacy would likely oppose the system.

International Business Machines' (NYSE: IBM) On Demand Computing initiative combines the SN and SW to create what Gary Cohen, general manager of IBM's Pervasive Computing referred to the use of computers in everyday life, including PDAs, smartphones and other mobile devices. It also refers to computers contained in commonplace objects such as cars and appliances and implies that people are unaware of their presence. Group, calls "a more democratized, inclusive way of thinking about technology that brings together people throughout an enterprise's departments and across its value chain."

In 2011, SN's full potential has yet to be achieved. But Qualcomm's CEO Paul Jacobs envisions a world in which sensor networks proliferate and part of the company's $2.5 billion research budget is going to realize that vision. According to the New York Times, Jacobs -- who has a PhD in Electrical Engineering from U. of California, Berkeley -- enjoys talking about SNs.

Jacobs has a different view of SNs. He calls it "the Internet of things" -- in which "TVs, dishwashers, running shoes, blood glucose monitors, picture frames, heart defibrillators and even Band-Aids have tiny chips or sensors that transmit information and communicate with mobile devices like smartphones and tablets," according to the Times.

Until Qualcomm finds a way to profit from realizing that vision, the company's operating performance has been solid. In its 2011 second quarter ending in March, its net income was $999 million and its non-GAAP earnings were 86 cents a share -- six cents better than expected -- on a revenue of $3.87 billion -- $250 million ahead of expectations. And Jacobs noted, "We are raising our revenue and earnings guidance for the year as the demand for smartphones across an array of geographies and tiers continues to grow," according to ZDNet.

In the last year, Qualcomm has been creating so-called Economic Value Added (EVA) Momentum, a sign that the company is generating cash flows that exceeds the capital required to finance its operations. Bennett Stewart coined the term -- it's a number calculated by dividing the change in EVA [Net Operating Profit After Tax - (Total Assets - Current Liabilities) x the Weighted Average Cost of Capital)]/Beginning Period's Revenues.

The best companies create value in excess of their cost of capital -- generating a positive EVA momentum. The higher the EVA momentum, the faster management is creating value. And Qualcomm's EVA Momentum is an impressive 9%. This figure comes from subtracting Qualcomm's 2009 EVA of ($756 million) -- it "destroyed value" that year -- from its 2010 EVA of $132 million and dividing the difference by its 2009 revenues of $10.4 billion.

Does the market recognize Qualcomm's ability to create value making it worth adding to your portfolio? To think about that, we can look at their price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Qualcomm stock is cheap -- trading at a PEG of 0.70. Its P/E is 23.7 and its earnings are forecast to grow 34% to $2.77 in 2011.

If Paul Jacobs can realize his vision of an Internet of things, Qualcomm stock could be a valuable addition to your portfolio.


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