Semiconductor stocks have suffered greatly this year, underperforming the market by a wide margin, observes Bob Ciura in Daily Profit.
Revenue and earnings growth across the industry have disappointed investors this year. Weaker-than-expected economic growth in emerging markets like China has led to disappointing demand and a global oversupply.
This has resulted in price erosion, as manufacturers are forced to cut prices in order to move inventory.
Within this environment, my preferred chip stock is Qualcomm (QCOM), a dominant player in smartphones across a wide range of phone makers.
It also has a broad range of chips for new, higher-growth areas such as the Internet of Things.
Due to the industry headwinds, revenue is down 14% through the first three quarters of the year. But the company's device sales rose 15% last quarter, year-over-year.
Pricing is a challenge, but the global smartphone boom remains intact. And Qualcomm is in the middle of a promising restructuring that could meaningfully reduce costs.
Qualcomm plans to reduce its costs by $1.1 billion annually starting in fiscal 2016, in part by reducing its workforce and also by cutting its stock-based compensation by $300 annually.
As a result, its margins should expand going forward. Management expects gross margins to reach 16% by the fourth quarter next year, with a longer-term objective of 20%.
At the end of last quarter, Qualcomm held $35.2 billion of cash, cash equivalents, and marketable securities, representing 7% growth from the same time last year.
Its long-term debt-to-equity ratio is a comfortable 30%. Improved profitability and a strong balance sheet could make Qualcomm the next company to announce a huge deal.
In the meantime, Qualcomm stock is cheap and pays a high dividend. It trades for 16 times trailing earnings and just 12 times forward estimates.
Qualcomm is a cash-generating machine with a fortress balance sheet. The company generated $1.75 billion of free cash flow last quarter alone.
All this cash is starting to pile up on the books and it's sharing its cash hoard with investors. Qualcomm returned $6.2 billion to investors just last quarter in dividends and buybacks.
The stock offers a 3.2% dividend yield, as well as strong dividend growth. In the past five years, Qualcomm has increased its dividend by 20% per year. If its turnaround remains on track, Qualcomm stock could offer an attractive total return moving forward.
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