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Is Broadcom Stock a Buy?

The Motley Fool logo The Motley Fool 9/7/2021 Leo Sun
a circuit board: Is Broadcom Stock a Buy? © Provided by The Motley Fool Is Broadcom Stock a Buy?

Broadcom's (NASDAQ: AVGO) stock rose to an all-time high after the chipmaker posted its third-quarter earnings on Sept. 2. Its revenue rose 16% year-over-year to $6.78 billion, beating estimates by $20 million.

Its non-GAAP net income increased 28% to $3.12 billion, or $6.96 per share, which topped estimates by a nickel. Its adjusted EBITDA rose 23% to $4.12 billion as its free cash flow grew 11% to $3.43 billion.

Broadcom's headline numbers look rock-solid, but does its stock still have room to run after nearly tripling over the past five years? Let's examine Broadcom's strategies, growth rates, and valuations to decide.

a circuit board: A semiconductor on a circuit board. © Getty Images A semiconductor on a circuit board.

A brief history of Broadcom

Broadcom was previously known as Avago Technologies, a Singapore-based chipmaker that primarily expanded via big acquisitions. Avago acquired the original U.S. chipmaker Broadcom in 2016, adopted its name, and relocated its headquarters to the United States in 2018.

The "new" Broadcom subsequently expanded into the infrastructure software market by buying CA Technologies in 2018 and Symantec's (NASDAQ: NLOK) enterprise security business in 2019.

Broadcom's core businesses

During the third quarter, Broadcom generated 74% of its revenue from its semiconductor solutions business, which produces a wide range of chips for the data center, networking, software, storage, and industrial markets.

Broadcom is a "fabless" semiconductor company that outsources its production to third-party foundries. This makes it different from IDMs (integrated device manufacturers) like Texas Instruments (NASDAQ: TXN) and Skyworks (NASDAQ: SWKS), which both manufacture their own chips with their in-house foundries. Fabless chipmakers face potential production bottlenecks at third-party foundries, so they're generally more exposed to the global chip shortage than IDMs.

Broadcom generated the remaining 26% of its revenue from its infrastructure software business. Here's how its two main businesses fared over the past year.

Revenue Growth (YOY)

Q3 2020

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Semiconductor Solutions

(4%)

6%

17%

20%

19%

Infrastructure Software

41%

36%

5%

4%

10%

Total

6%

12%

14%

15%

16%

Source: Broadcom. YOY = Year-over-year.


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Broadcom's chipmaking business suffered pandemic-related disruptions across the networking, auto, and industrial markets throughout 2020. However, the growth of its infrastructure business, which lapped its acquisition of Symantec's enterprise security business in the first quarter of 2021, cushioned the blow and bought its chipmaking business more time to recover.

Broadcom's semiconductor business recovered this year as the pandemic-related headwinds waned and the cloud, data center, and wireless markets heated up again. It also likely profited from robust sales of its wireless chips to Apple (NASDAQ: AAPL), which accounted for 15% of its revenue last year. Those strengths easily offset its slower sales of data storage chips to enterprise customers.

Broadcom isn't facing a supply crunch like other fabless chipmakers yet, since its chips are primarily manufactured with older processes rather than the newer processes that have been crowded with orders for higher-end chips. Starting last May, Broadcom also implemented tighter reviews of its backlog and supply chain to carefully balance supply and demand across its main end markets.

Broadcom expects its revenue to rise 14% year-over-year in the fourth quarter, which implies its full-year revenue will increase 15%.

Consistent earnings growth with expanding margins

Broadcom is firmly profitable by GAAP measures, but its adjusted EBITDA, adjusted EBITDA margins, and free cash flow growth cut through the lumpy earnings growth caused by its numerous acquisitions:

Period

Q3 2020

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Adjusted EBITDA Growth (YOY)

9%

21%

21%

23%

23%

Adjusted EBITDA Margin

57%

59%

59%

60%

61%

Free Cash Flow Growth (YOY)

33%

36%

35%

12%

11%

Source: Broadcom. YOY = Year-over-year.

Broadcom expects its adjusted EBITDA margin to hold steady at 61% in the fourth quarter, which implies its adjusted EBITDA will rise about 17% in the fourth quarter and increase roughly 21% for the full year.

Broadcom attributes that stable growth to a favorable mix of higher-margin semiconductor products and rising margins at its infrastructure software business. Its free cash flow growth has decelerated this year, but it still easily covered its dividends with less than half of its FCF over the past 12 months. It currently pays a forward dividend yield of 2.9%.

Broadcom's stock is still surprisingly cheap

Broadcom's growth will likely decelerate in fiscal 2022 as its year-over-year comparisons normalize, but its stock still looks cheap at 17 times forward earnings. TI, which is expected to generate modestly higher revenue and earnings growth than Broadcom this year, trades at 23 times forward earnings.

Broadcom had a great run over the past few years, but I believe it will still head higher over the long term. It's well diversified, isn't struggling with any major chip shortages, pays out reliable dividends, and is expanding its margins even as it continues to pursue new acquisitions.

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Leo Sun owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Texas Instruments. The Motley Fool recommends Broadcom Ltd and Skyworks Solutions and recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

 
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