Broadcom (AVGO) is a prominent tech company specializing in semiconductor and infrastructure software. It did not please investors much in 2024, but that was expected, considering that management was transparent about the weakness in its non-AI business. Despite the low-key results so far in 2024, I will explain why I think it’s a solid long-term stock.
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Before I elaborate on my position, you need to understand that the company offers many different things, including cybersecurity software, data center hardware, cloud infrastructure software, and more. As of writing, the stock is up a modest 50% for the year. While that’s not impressive when you compare it to other AI stocks like Nvidia (NVDA), which is up nearly 183% for the year, it should not imply that the stock can’t go higher.
I am bullish on Broadcom for the long term because of its position in custom silicon chips and its software business, particularly its VMWare part.
Broadcom Is a Leader in Custom Silicon Chips
Broadcom’s leadership position in custom silicon chips is central to my thesis for the stock. As the name suggests, custom silicon chips are tailored to suit specific use cases, unlike generic processors like GPUs that are good at multiple tasks. A technical term for this hardware is Application Specific Integrated Circuits (ASICs), and Broadcom makes the best one. The primary benefit of an ASIC over a GPU is energy savings.
Therefore, as data center operators look for energy-efficient chips and even make their own custom silicon to handle AI workloads, Broadcom will be on their list of places to shop. The company currently makes ASICs for Alphabet’s (GOOG) Google, Meta Platforms (META), and TikTok-owner ByteDance. According to a Bloomberg report from October 2024, it also recently added OpenAI to its list of customers for AI chips.
Moreover, Broadcom’s 60% market share in custom ASICs should allow it to increase prices and boost margins. While some of its high-profile customers may try to replicate the company’s custom chip design technology to avoid paying hefty prices, they might not all succeed. I do not see margin erosion for Broadcom because it is differentiated in the custom silicon market and can always win more customers.
I want to remind investors that Broadcom is one of the most profitable companies, with cost-management capabilities and pricing power. Over the trailing twelve-month period, Broadcom’s gross margins and operating margins stand at 64% and 30.5%, respectively. Given its dominant market share in custom AI accelerators, I am confident that Broadcom can maintain these margins in the long run.
VMware Provides Broadcom a Meaningful Hedge
The other thing that supports my bullish view of Broadcom is its VMware business. The bears are concerned with the weakness of the company’s traditional business, but they aren’t looking at the big picture. This technology company has moats in both software and hardware. Broadcom’s businesses are hedged, especially with VMware, a niche software that’s a key tool for enterprises today.
Broadcom bought this virtual machine software company for $69 billion in November 2023 and added it to its software portfolio. In my opinion, this was a smart move, and that’s being reflected in the company’s financial performance. VMware has driven overall sales growth for Broadcom in 2024, and I think there’s still an upside to it.
Moreover, VMware is a key player in the virtualization market and has an estimated market share of 44.5%, according to data from 6Sense. It’s popular among businesses across several industries that use “virtual computers” to reduce their overhead. It’s a high-margin business that can offset weaknesses in other parts of Broadcom.
Additionally, Chief Hock Tan is committed to making VMware another success for the company. AVGO’s management is progressing well in bringing costs down and boosting sales. VMware revenue grew to $3.8 billion from $2.7 billion, and costs dropped to $1.3 billion from $1.6 billion between FQ2 and FQ3 2024. Post-integration, VMware provides Broadcom with strong revenue diversification and a meaningful hedge.
Is Broadcom Stock Cheap?
Broadcom is trading at 26.7 times its FY2025 EPS estimate of $6.2 right now, and I do not think that’s too expensive. Analysts are projecting 28% earnings growth next year, and I think Broadcom can deliver. The company’s two high-growth businesses, which make me bullish on the stock, could justify the current multiple, but there’s a catch. I suspect recovering cyclical businesses like wireless and broadband will take over investor sentiment in the near term, causing shares to fall further.
However, if you have the stomach to absorb some near-term downside, here’s what I want you to focus on: Broadcom’s infrastructure software and networking revenue. Just parsing through the filings and management’s commentary throughout 2024 shows you the story. Broadcom’s networking revenue exceeded 40% throughout 2024, and it was driven by demand for its custom silicon. Its infrastructure software revenue has grown by more than 150% throughout 2024, and it was driven by VMware.
Therefore, my move would be to wait for the bears to sell a bit more and then purchase shares at a lower price. I believe Broadcom’s long-term growth prospects remain intact as the company sits on a sizable AI opportunity and completes its integration with a niche software company. Maybe investors will assign it a higher multiple as its traditional business stabilizes, but right now, the valuation appears to be slightly ambitious relative to the 5-year historical average of 19.
Analysts’ Take on Broadcom Stock
On the Street, Broadcom stock sports a consensus Strong Buy rating based on 23 Buy and 3 Hold recommendations. The average price target of $199.80 represents an upside of 20.60% from current levels.
The Bottom Line
Broadcom is one of the most profitable technology companies in the world, with strong moats in both hardware and software. The company’s technological prowess in custom silicon chips should allow it to drive long-term growth as it enables key use cases in AI and high-performance computing. Broadcom’s software business also provides a durable hedge to offset any cyclical weaknesses in its legacy hardware business. While the stock isn’t that expensive, it could get cheaper, so investors should wait for a pullback.
