Broadcom Stock: Buy, Sell, or Hold?

Broadcom's recent business momentum has been impressive. But the artificial intelligence (AI) business underneath the surface is exploding so fast that its growth rate is about to accelerate massively. This setup makes it an interesting time to look at the stock. Are shares cheaper than they look, given the momentum around the corner? And is the company's accelerating momentum sustainable?

Of course, just because a business is great doesn't automatically make the stock great. So we need to look at both the business and the stock's valuation. With shares of Broadcom (NASDAQ: AVGO) commanding a price-to-earnings ratio of 62 as of this writing, investors are right to wonder if all this good news is already baked into the price.

So, does the company's exceptional momentum make the stock a buy? Or should investors stay on the sidelines?

Image source: The Motley Fool.

Explosive AI momentum

Broadcom's first-quarter revenue hit a record $19.3 billion -- up 29% year over year. But its fiscal first-quarter AI semiconductor revenue skyrocketed 106% year over year to $8.4 billion. This growth is being fueled by aggressive capital expenditures from major technology companies, or hyperscalers, that are turning to Broadcom for custom AI accelerators and advanced networking chips.

And the momentum is only accelerating. Management guided for fiscal second-quarter revenue of approximately $22 billion. This implies a blistering 47% year-over-year growth rate.

But here's where things really get wild. The company expects second-quarter AI semiconductor revenue to reach $10.7 billion -- implying a 140% year-over-year surge.

This top-line growth is translating into exceptional profitability. Broadcom reported fiscal first-quarter adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $13.1 billion, representing an incredible 68% of total revenue.

Visibility into the future

One of the hardest things to underwrite in the semiconductor industry is the durability of a growth cycle. But Broadcom benefits from a surprising level of visibility into its customers' needs because of the types of customers it serves.

Who are its customers for its custom AI chips? The company works with six major large language model (LLM) customers, including Alphabet, Meta Platforms, Anthropic, and even OpenAI.

Making a case for its visibility into these companies' roadmaps, Broadcom co-designs custom AI chips directly with a handful of massive hyperscaler customers.

These customers are laying out billions of dollars in capital expenditures to build data centers -- and Broadcom is sitting right in the middle of that spending.

This dynamic is fundamentally different from selling off-the-shelf components. Broadcom's deep integration into its customers' product roadmaps provides a clear line of sight into future demand, reducing the risk of a sudden drop-off in sales.

"Today, in fact, we have line of sight to achieve AI revenue from chips, just chips, in excess of $100 billion in 2027," explained Broadcom CEO Hock Tan during the company's fiscal first-quarter earnings call. "We have also secured the supply chain required to achieve this."

A valuation that makes sense

Of course, this predictability comes at a price.

But given the company's extraordinary growth expectations, there's probably a better valuation metric than its price-to-earnings ratio of 62 to use to judge it. A more telling valuation metric for Broadcom is its forward price-to-earnings ratio -- the stock's price as a multiple of the analysts' consensus earnings-per-share forecast over the next 12 months. By this metric, Broadcom's stock looks more appropriately priced. Broadcom's forward price-to-earnings ratio is about 28 as of this writing.

This, however, is still a premium valuation -- one that assumes excellent execution and the continuation of the AI boom. Additionally, a valuation like this leaves very little room for error if hyperscalers suddenly decide to pull back on their capital expenditures.

But given the company's underlying fundamentals and the unique "sticky" nature of Broadcom's customer relationships, this premium is arguably justified.

While I would normally balk at paying 28 times forward earnings for a semiconductor company, Broadcom's unique position as a structural partner to the world's largest technology companies makes it an exception. I think investors who buy shares today and hold them for the long haul could be handsomely rewarded.

Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and Meta Platforms. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.