Opinion: Broadcom Is the Canary in the AI Coal Mine -- Just Not in the Way You Think

Broadcom (NASDAQ: AVGO) shares crashed on Thursday following the release of its Q2 results the previous evening. The numbers were fine; revenue of $22.2 billion was up 48% year over year, topping estimates. But guidance disappointed... sort of.

CEO Hock Tan only reiterated the company's ambiguous expectations for full-year artificial intelligence (AI) chip revenue of "in excess of $100 billion" from its Q1 report. Investors wanted Broadcom to raise its own bar. When it didn't, they revolted, sending Broadcom shares as much as 14% lower, and dragging a handful of other AI tech stocks down with it.

A growing number of investors seem to fear this single-day setback could mark the beginning of prolonged weakness stemming from AI's lack of clear, practical value. After all, most of Broadcom's business comes from other AI companies building capacity on the mere hope that enough actual business will follow. If this worry is legitimate, a sweeping correction is likely to come sooner rather than later.

Image source: Getty Images.

This line of thinking arguably overstates what's actually happening here and now with Broadcom, however. The AI industry's future is legitimately bright. It's just that most investors (perhaps without even knowing it) innately feel too many artificial intelligence stocks have gotten more than a little ahead of themselves price-wise. Broadcom simply provided the excuse needed to start right-pricing these tickers.

Just a routine right-pricing

Broadcom shares are currently priced at 37 times this year's expected earnings, for perspective, and 22 times analysts' profit projections for next year. Both are unusually high (although the 2027 valuation isn't exactly outrageous).

And Broadcom isn't alone. Numbers from Yardeni Research highlight the "Magnificent Seven" stocks -- all of which have a hand in the AI business -- boast an average forward-looking price/earnings ratio of 26.3, versus an average of only 19.2 for every other name in the S&P 500 (SNPINDEX: ^GSPC). Even if they don't recognize it, this may be making many investors subconsciously uncomfortable. They've simply been waiting for the right catalyst to start the price correction that most AI tickers need at this time.

That's it. Thursday's setback isn't the beginning of a sweeping indictment of AI as a whole. Although Broadcom's full-year AI chip sales guidance of "in excess of $100 billion" is disappointingly non-descript, even at the lowest possible figure of $100 billion, that's still miles ahead of last year's total top line of $63.9 billion, roughly 40% of which came from software -- that means at least 56% revenue growth ahead.

Rather, Thursday's stumble from Broadcom's stock suggests investors are just taking the opportunity to dial back some of these names' valuations to levels that make a little more sense for an industry that's still growing, but evolving in mostly unpredictable ways. And, it could take a bit for this correction to run its full course.

Just don't hold out or hold off too long getting in, or getting back in. At a price just below $400, Broadcom shares are valued at about 20 times next year's expected earnings. Moreover, prior to Wednesday's report, the analyst community had collectively valued this stock at $505.75 per share. We're already well below that mark, yet little has actually changed with their overall bullish thesis.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Broadcom. The Motley Fool has a disclosure policy.