Tech stocks have been under pressure since the start of the year. Many investors wonder if it is time to take profits off the table and wait for a better opportunity or if it is time to stay invested in tech stocks.
However, now could be a great time to invest in high-quality technology companies because the market has fallen. Broadcom (AVGO) is a company you should be watching out for.
It is a multinational semiconductor and communications equipment corporation headquartered in Irvine, California. Broadcom’s products are primarily used to manufacture computer processors, network switches, broadband wireless access devices, and related systems for data centers.
The semiconductor market will continue growing as more and more electronic devices such as cars, data centers, and industrial machines become increasingly prevalent. Broadcom’s infrastructure software will continue to be attractive due to its current demand in the industry.
Over the last five years, Broadcom’s stock has already significantly outperformed major companies in the field like Texas Instruments (TXN) and NXP Semiconductors (NXPI). That trend is continuing, as the company is doing better than ever before.
In the near term, Broadcom’s growth rates look impressive, and so does its valuation. However, it trades at a low multiple because of broader macro headwinds and expectations that the chip shortage will soon end to create a cyclical slowdown. Regardless, the company should remain very successful moving forward. With Broadcom at such a low price point, its value will likely increase in the coming months.
Why is Broadcom Doing Well?
In the first quarter of 2022, semiconductor solutions made up 76% of Broadcom’s revenue. These chips cover a wide range of areas, such as the data center, networking, software & storage, and industrial industries.
The company’s software business is new, but the other 24% of revenue was generated from the acquisitions of CA Technologies and Symantec’s enterprise security.
Broadcom’s revenue increased by a double-digit percentage for the sixth consecutive quarter. Its latest results beat estimates and are evidence of its consistent success at running a fruitful company.
With the semiconductor sector leading in the S&P 500 (SPX), it is no surprise that its semiconductor business was worth the most overall. It’s also interesting to see how strong demand for chips has been across key markets such as cloud computing, data centers & wireless connectivity.
Broadcom’s revenue is growing fast, and it will likely beat analyst expectations in Q2.
Apple’s (AAPL) revenues are growing year after year, and the company uses these sales to provide a substantial boost going into the next quarter. Usually, this happens because the sales of their respective products — iPhones, iPads, and Macs — have good momentum at hand. These products use Broadcom’s chips. It’s important to note that Apple constituted almost 20% of Broadcom’s revenue in 2019.
There are pros and cons to having such a big client. On the one hand, the company knows that Apple is solid as a rock. Although inflation is on the rise, Apple’s hardware sales have shown to be very sticky due to the company’s brand power. Apple understands this and is willing to raise prices if it means more money for its business.
Of course, on the flip side, diversification will not hurt the company. However, I don’t expect this to become a make-or-break issue with investors.
Profits are Expanding, and Margins are Increasing
Top-line growth is great, and it’s usually what investors are looking for when a company is new and growing. It can tell investors how fast a company is growing and help them decide whether they should invest in it.
However, for long-term success, the company will need to generate increasing levels of revenue & boost its profit margins. Broadcom is generally profitable by GAAP and non-GAAP standards. Both the figures have both reached historically strong levels year-over-year. Over the past year, its adjusted EBITDA margins have been consistently increasing both sequentially and annually.
The company is attributing its continued growth to increased margins and pricing power. Broadcom is usually a bit unpredictable in terms of its forecasts. It is good to note the forecast changes and be prepared so you can manage your portfolio accordingly.
The company is expected to have an EBITDA margin of 62.5% in the second quarter, up from last year’s margin. However, it predicted its first-quarter adjusted EBITDA margin would only be about 61%, beating this guidance.
Broadcom posted 13% year-over-year free cash flow growth. Its FCF margin is nearly half of its revenue, and it was also consistently above 40% last year. Texas Instruments & NXP Semiconductor ended the year with different FCF margins: TXN had a 34% margin while NXPI had a much lower 21%. The company is trading at a discount relative to these two big semiconductor companies, an additional reason to consider the stock.
Another area where Broadcom is doing well is its dividend. Through share buybacks and dividends, Broadcom has returned most of its free cash flow to its investors over the past decade. You can be confident that the dividend is safe and that the company will continue to thrive in the future.
Wall Street’s Take
The sentiment on AVGO stock is bullish. It has a Strong Buy consensus rating based on 15 Buys assigned in the past three months. The average Broadcom price target of $710 per share implies upside potential of 21.7%.
The Bottom Line on Broadcom
After a quick recovery in 2018, shares have more than doubled those seen in the broader market. As one of the world leaders in 5G networks, investors can’t wait to see how that will affect businesses in the future.
Congrats to Broadcom – its 5G rollout worldwide helped lead to its rapid growth. The company has seen lots of revenue growth and a high compound annual growth rate from a low base. This is definitely a business to watch, and the cash machine has only been running faster and smoother over time.
Broadcom used to convert about 20% of its annual revenue into free cash flow. It is now doing more than double that and is converting nearly 49% of the yearly revenues into cash.
The company’s overall success is reflected in its strong fundamentals. AVGO stock seems like an excellent choice for portfolio diversification.
Read full Disclosure
