When there’s a gold rush, don’t join in. Start a company that sells picks and shovels. That’s where the real money is.
It’s a bit of a cliché, but it works.
Today, there’s a gold rush in new technology. And the secret to consistently making money in this rapidly-changing sector is with suppliers, not the companies who get their name on the end product.
Sure, all the hype is currently on companies like LinkedIn and Facebook. But for every “Web 2.0” company, you still need something to run it on. That means wiring, computer chips, and other pieces of infrastructure.
Take smartphones for example. You could own Apple, Verizon, or Research in Motion to profit from the latest trends in smartphone use. But that’s like watching horses jockey around. Instead, consider going long Qualcomm (QCOM).
That’s because Qualcomm is the leader in smartphone technology. Their chips help run every iPhone, Droid, and Blackberry. More importantly, they’ve been expanding their profit margins by licensing out their products and letting someone else spend the capital to manufacture them.
On Wednesday, QCOM reported that chip sales were up 14% year-over year, free cash flow was $1.69 billion, and it expected to see a 16% rise in royalty-paying products.
What’s the value to this approach? It means Qualcomm isn’t tied to the success of one particular brand of smartphone. As long as consumers continue to upgrade and better smartphones are developed, there’s opportunity for Qualcomm to keep growing. They’re not tied to the individual fortunes of Apple, Verizon, or Research in Motion.
Aside from growing, there are only two other ways a company can reward shareholders: buy back shares, or implement a dividend. Qualcomm does both. The company has a $3 billion buyback program in place, about 3% of the company’s outstanding value. The dividend is 1.7%, a little low for large-cap tech, but the total payout has almost quadrupled since 2004. With these numbers, expect further dividend increases in the future.
Qualcomm isn’t alone. Corning Glass Works (GLW) has developed an incredible niche in the display industry. With its Gorilla Glass, used in the iPad and other tablet devices, touch-screen devices have become durable and proliferated throughout the market.
Corning sports a 2.2% dividend yield, profit margins over 40%, net cash of over $4 billion, and a PE ratio of 7, less than half the overall market. It’s more of a value play compared to Qualcomm, which has better growth prospects at the moment.
Whether you’re a growth investor or a value investor, there’s one clear lesson. Own the suppliers, not companies making the next hyped (and soon to be outdated) product.
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