Broadcom Stock Drops After Strong Earnings -- Time to Buy?

Few artificial intelligence (AI) semiconductor stocks have had a better run than Broadcom (NASDAQ: AVGO) during this current bull market. The stock has posted an average annualized return of 67% over the past three years, which stacks up favorably with Nvidia, Intel, Advanced Micro Devices, and other leading chipmakers.

Broadcom stock dropped about 15% in the first quarter due to its high valuation and concerns about margin compression heading into the year.

But since April, it spiked 55% to reach $481 per share on June 2, leading up to the second-quarter earnings release on June 3. But since then, the stock has plummeted 21% to $380 as of June 23.

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Shares fell despite a strong earnings report that saw sales surge 48% year over year to a record $22.2 billion. Its AI chip revenue jumped 143% to $10.8 billion, driven by demand for AI accelerators and AI computing. That AI revenue is anticipated to rise 200% in the fiscal third quarter to $16 billion.

It raises the question: Why has Broadcom's stock tanked since earnings were released?

Is Broadcom stock a buying opportunity?

Often, when there's a sell-off like this for a high-performing company, investors are taking profits after a big run when the valuation has skyrocketed. Broadcom stock had risen 55% in two months leading up to the fiscal second-quarter earnings release, and its price-to-earnings ratio (P/E) had spiked to 81, up from 69 in late January.

There were also some concerns that its AI semiconductor revenue projections for the third quarter missed analysts' estimates. The 200% increase to $16 billion was apparently not enough, as analysts had expected $17 billion.

In addition, Broadcom guided for slightly lower margins in the third quarter, with the gross margin targeted at 74%, down from 77% in the second quarter, as management said on the second-quarter earnings call. And the quarter's margin was also down year over year.

This is mainly due to a changing product mix, as lower-margin but faster-growing AI chips make up a larger portion of overall revenue. So Broadcom is bringing in tons more revenue, but at slightly lower margins, which will eventually find its level.

The broader concern is valuation: when a stock trades at such high multiples, compressed margins become a bigger issue and make it harder to justify them.

But in the long term, Broadcom stock has a low five-year price-to-earnings-to-growth ratio of 0.68, indicating it is a value stock based on its earnings expectations. And in the nearer term, its forward P/E during this sell-off has dropped to a more reasonable 32, from 37 a few months ago.

Ultimately, this sell-off creates a great opportunity to buy one of the leading AI stocks at a discount.

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices, Broadcom, Intel, and Nvidia. The Motley Fool has a disclosure policy.