After Earnings, Is Broadcom Stock a Buy, a Sell, or Fairly Valued?

Broadcom AVGO released its fiscal second-quarter earnings report on June 12. Here’s Morningstar’s take on Broadcom’s earnings and stock.

Key Morningstar Metrics for Broadcom

• Fair Value Estimate: $1,550.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

What We Thought of Broadcom’s Q2 Earnings

• We raised our fair value estimate of Broadcom stock to $1,550 per share from $1,350. We also raised our medium-term growth projections based on a higher artificial intelligence forecast, as Broadcom is exceeding our expectations so far in fiscal 2024.
• Broadcom has a significant artificial intelligence chip opportunity, split between merchant networking chips and its custom AI accelerator business that sells into Alphabet GOOGL and Meta Platforms META. We expect AI to make up close to half of Broadcom’s overall sales in fiscal year 2028, which is impressive against sizeable non-AI chip and software businesses.
• We continue to see Broadcom as overvalued, with the market pricing implying stronger growth in AI than we forecast. Our forecast is for more than 50% compound annual growth for Broadcom’s AI sales through fiscal 2028, inclusive of more than 200% growth in fiscal year 2024.
• Broadcom announced a 10-for-1 stock split, effective in July. This won’t change our valuation, but it should make the stock more available to smaller investors.

Fair Value Estimate for Broadcom

With its 3-star rating, we believe Broadcom’s stock is fairly valued compared with our long-term fair value estimate of $1,550 per share. Our valuation implies a fiscal 2024 adjusted price/ earnings multiple of 32 times and a fiscal 2024 enterprise value/sales multiple of 15 times.

In our view, Broadcom’s primary valuation drivers are its networking business and its ability to extract growth and operating leverage from VMware. We also anticipate continued inorganic growth over the long term. We model 18% revenue growth for Broadcom, including the inorganic contribution from VMware, through fiscal 2028. We see high artificial intelligence sales driving supernormal growth in the next five years, but for longer-term durable growth to settle in the high-single digits on an organic basis.

Read more about Broadcom’s fair value estimate.

Economic Moat Rating

We believe Broadcom has a wide moat, stemming from intangible assets in chip design and switching costs for its software products. The firm’s strength in both chips and software lets it earn terrific accounting and economic profits, and we believe its competitive positioning will likely allow it to do so for the next 20 years. Most of the company’s business is in semiconductors, with broad end-market exposure across enterprise networking, wireless chips for smartphones, broadband access, and storage applications. We see the two largest exposures here, networking and wireless chips, benefiting from the firm’s expertise in chip design.

Read more about Broadcom’s economic moat.

Financial Strength

We anticipate Broadcom focusing on strong cash generation. Over the short term, we expect the firm to focus on paying down the debt taken to acquire VMware. Over the long term, we expect it to focus on growing its dividend and bolting on more acquisitions. As of January 2024, Broadcom held $12 billion in cash and equivalents versus $76 billion in gross debt, with approximately half of that taken on to finance the 2023 acquisition of VMware. Given the long-dated nature of its outstanding notes and robust cash generation, we aren’t worried about the firm’s debt.

Read more about Broadcom’s financial strength.

Risk and Uncertainty

We assign a Medium Uncertainty Rating to Broadcom. As a chipmaker, it is vulnerable to market supply and demand cycles. Though it has been able to offset cyclicality in recent years with its software exposure and networking strength as a buoy, future cycles may not look similar. It also heavily relies on Taiwan Semiconductor Manufacturing TSM for its chips, and any supply constraints could hamper its ability to ship to customers. Nonetheless, we believe Broadcom is a preferred customer of Taiwan Semiconductor and would receive high priority in such a scenario, both for its scale and lengthy relationship.

Read more about Broadcom’s risk and uncertainty.

AVGO Bulls Say

• Broadcom is a poster child for operating efficiency. It earns excellent operating margins and generates enormous cash flow. It is particularly strong at acquiring companies and trimming excess expenses.
• Broadcom’s networking and wireless chip businesses boast best-of-breed technologies, along with marquee customer relationships with Apple AAPL, Alphabet, Cisco Systems CSCO, Arista Networks ANET, and others.
• We believe Broadcom will significantly benefit from rising AI spending, which we expect to spur significant growth for its networking semiconductor sales.

AVGO Bears Say

• Broadcom has sizable exposure to non-moaty businesses, like its broadband and storage chips.
• Broadcom’s software portfolio holds many legacy and mature businesses, like virtualization and mainframes, which we think will exhibit lower growth.
• Broadcom relies heavily on acquisitions to expand its portfolio, yet tends to focus more on expense cutting rather than seek strategic synergies for its deals.

This article was compiled by Sokhoeun Noeut.