3 Telecom Stocks To Buy

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As competition heats up in the smartphone market, there will be increasing demand for innovation. In such an environment, telecom suppliers will, we are told, flourish. While it's true that telecom suppliers will almost surely see a nice rise in income, investors won't necessarily see the fruits of this rising tide. Much of the upside could have been factored into some stocks already.

Qualcomm (NASDAQ: QCOM)

In my view, Qualcomm is one of the safer investments, despite its pricey multiple of ~19x past earnings. By virtue of being one of the largest communications equipment suppliers, it has strong leverage in the market and has a sustainable pool of customers. Its EPS has grown by 13.4% annually over the past 5 years, and analysts are forecasting 14.6% annual EPS growth over the next 5 years. I believe that this sets the bar fairly low, since the past 5 years are an easy comparison in light of a depressed macroeconomic period.

It should further be noted that Qualcomm has leading ROA, ROE, and ROI in the market. With a quick ratio of 3.3 and $13.9 billion in net cash, the company is likely to pursue high-growth M&A activity that can help it gain scale in emerging markets. While China may have seen slower growth than expected of late, its increasingly wealthy population is likely to demand a greater number of communication devices that are inevitably built through Qualcomm technology. I write "inevitable" because all significant wireless device sellers link back to Qualcomm, which, according to Credit Suisse, has even gained WCDMA chipset market share to a majority. 

My one main concern is that, over the next few years, Qualcomm is forecasted to spend less as a percent of revenue on R&D. Though it has compatibility with all of the major smartphone operating systems, the telecom industry is fast moving and not for those that rest on their laurels. Even worse, the lower expenditure on R&D as a percent of revenue could be an indication of the growing reality that Qualcomm is approaching the "law of big numbers." Throwing more dollars at a source won't necessarily generate the best results, but that's what we hope for in high growth companies.

Cisco (NASDAQ: CSCO) & Broadcom (NASDAQ: BRCM)

Cisco is another relatively safe stock to consider. Though it finished 2011 as one of the biggest market share gainers in the industry, it is still well below its earlier control of 70% of the market. Towards continuing the positive momentum, management is, according to FBN Securities, getting aggressive on cloud computing despite lowering growth targets from around 15% to 6%. Given that it generates $2 billion in free cash flow every quarter, the company can buy back a large amount of shares to hedge against macro uncertainty. That's around a 10% yield against the market capitalization.

The company has also already hit its floor at 12x past earnings. My math shows that it has around a 45% margin of safety at a 15x multiple, 10% discount rate, and 9.8% annual EPS growth rate. However, I recommend buying shares alongside an investment in Broadcom to capitalize more directly on smartphone tailwinds.

Unlike Qualcomm and miserly Cisco, Broadcom spends a significant amount of its free cash flow on R&D. These investments have resulted in the company being able to cost-effectively produce chips with a variety of functions. This has, for example, fed right into the craze for smaller and smaller devices.

As the leader in networking and broadband chip segments, Broadcom already has solid foothold to cross-sell its way into different but related markets. According to Morningstar, the company has won several mobile phone contracts from brands like Samsung and Nokia that grant it credibility in the handset market. Furthermore, the company's already broad product portfolio hedges against uncertainty, and thereby reduces volatility for investors.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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