Two Royalty Stocks for 2020 (and Beyond)

This high-margin business model spells consistent profits.

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  • While there are plenty of business models out there for how to operate a company, a great one for shareholders is in the royalty space.

    Simply put, a royalty company owns a patent or provides capital to another company. When that other company makes a product, a tiny amount of sales go to the royalty company.

    This provides a number of advantages for the royalty company. They have no production risk, no sales, and can operate with very few employees.

    That means these companies can produce higher profit margins, and reward shareholders with higher profits and generous dividends.

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  • While royalty companies often get mentioned in the commodity space, they can exist in just about any sector. Let’s look at two such companies that can continue to deliver great profits to investors in the next year.

    Royalty Giant #1: Qualcomm (QCOM)

    Although known as a tech firm with a focus on wireless chips for mobile devices, Qualcomm actually structures itself as a royalty company. It creates new technologies, patents them, then allows other companies to produce products, getting a cut based on the sale of each trade.

    That’s a great business. Qualcomm manages to profit no matter what cell phone manufacturer is killing it in the marketplace right now. If one company sees substantial gains in market share, Qualcomm would only be affected by things such as the purchase price.

    That’s how the company managed to get into a legal battle with Apple over royalty payments. Because Apple is able to charge a premium for its iPhones, the company had to pay a higher royalty to Qualcomm. After years of a legal battle, 2019 marked a new agreement between the companies—and one that involved paying back Qualcomm for past sales.

    That helped shares surge this year with a 58 percent return. But as a royalty company, it’s going to continue to be successful for years to come. And with ownership of some of the leading tech in the upcoming 5G network, Qualcomm is in the right place at the right time.

    Shares trade at just 18 times forward earnings, even after their great return this year. And with a profit margin over 18 percent, but a return on equity over 150 percent, the company is well managed and uses its balance sheet to provide shareholders with great results.

    Best of all, shares offer investors a 2.5 percent dividend yield at current prices. While not as high as in the past, it gives investors a nice cash return while waiting for investments in the 5G space to play out in the years ahead.

    We like shares up to $90.00.

    While shares may not perform as well in 2020 as they did this year, despite what some traders thought, speculators could do well with the January 2021 $100 calls. A bet on another 12 percent rally in shares, they trade for around $6.00 right now, or $600 per contract, providing ample upside potential in the next year.

    Royalty Giant #2: Nike (NKE)

    Although the stock market wasn’t that impressed with the company’s most recent earnings report thanks to their forward-looking statements, the company crushed it on earnings, showing solid growth.

    What’s more, the apparel and shoe company really just makes designs that it then sends out to others to produce. That makes the company a royalty firm with no fears of production issues.

    And with a company embracing a younger and more international demographic, sales continue to rise. The company’s use of controversial figures and political awareness has proved more of an asset than a liability, based on where it’s getting sales, and shareholders have taken notice.

    This is another company that’s beaten the market this year, with a 7 point advantage over the market index. And with an 11 percent profit margin, it’s also doing better than the apparel industry on average thanks to its outsourcing of production in a royalty-model fashion.

    Shares are a buy up to $102.00. At that price, they yield just under 1 percent.

    Speculators should expect further moves in 2020, making the January 2021 $110 calls. Trading for around $6.50, or $650 per contract, they’re an inexpensive way to control $10,000 in shares now with a bet on a move higher. Another 10-20 percent move in shares should send this option in-the-money, and could provide a double depending on how quickly that occurs.

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