Broadcom’s (NASDAQ: AVGO) extraordinary 125% increase from $110 levels in early 2024 has investors pondering if the AI chipmaker can replicate its success. What might lead the stock to rise to $500+ levels from here in the coming years? The most persuasive factor is Broadcom’s custom silicon division. AI-related semiconductors now account for over 50% of Broadcom’s sales, marking a significant shift in the company’s revenue composition. The management of the company assesses the serviceable addressable market at $15-20 billion. The custom chip sector shows tremendous growth potential. The overall market for custom chips could expand to approximately $55 billion by 2028, effectively more than tripling from current figures. This growth reflects hyperscalers’ increasing preference for purpose-built silicon over generalized processors. Additionally, if you’re seeking a more consistent route to gains than investing in a single stock, consider the High Quality portfolio, which has surpassed the S&P and yielded over 91% since its inception. Also, check out – BigBear.ai: What’s Happening With BBAI Stock?
Other elements are at play as well.
- Strengthening Customer Partnerships
- Broadcom is building robust, high-value partnerships with significant hyperscalers, including a collaboration with OpenAI for chip development, working in conjunction with TSMC.
- There are also indications of Broadcom working with Apple on AI chip development.
- Broadcom is actively creating AI chips for three large cloud clients, which reflects diversified revenue streams outside its current partnerships. Also, check out – Broadcom’s Revenue Comparison
- Accelerating Inference Demand
- While initial AI investments emphasized training chips, the need for inference chips is now the main growth driver.
- OpenAI’s rapid expansion, with its annual recurring revenue exceeding $10 billion (almost doubling from $5.5 billion at the end of 2024), is creating substantial demand for inference chips.
- As AI applications move from development to deployment, inference workloads necessitate specialized networking and processing abilities, areas where Broadcom excels.
- Product Innovation
- Broadcom continues to enhance its technological leadership. The company recently delivered its Tomahawk 6 networking chip, which boasts double the performance of its predecessor, showcasing Broadcom’s enduring competitive advantage.
- Moreover, Broadcom’s co-packaged silicon photonics technology strategically positions it to fulfill the needs of next-generation AI infrastructure.
Path To 2x Growth
Broadcom’s impressive earnings growth can support elevated valuations. The company’s revenue is anticipated to grow at a high teens average annual rate to over $100 billion by 2029. Broadcom has high profitability with its adjusted net income margin of 50% in the past twelve months. This indicates that the impact on earnings will be more significant than on the top-line.
At its present levels of $265, AVGO stock is trading at 45 times its trailing twelve months adjusted earnings of $5.84 per share. Additionally, check out – Broadcom’s Valuation Ratios. Maintaining this multiple could push the stock to around $500 within that timeframe. A higher multiple would enable an even greater increase. The existing customer relationships frequently involve multi-year commitments and substantial switching costs, which provides Broadcom with revenue visibility and pricing power, potentially maintaining premium valuations.
For this multiple to broaden, Broadcom must showcase sustained strong annual revenue growth in AI segments, expand its market share in the custom silicon sector, focus on further margin improvement from a higher-value product mix, and secure contracts with new clients.
In summary, Broadcom’s journey to doubling relies on capturing a significant portion of the growing custom chip market while preserving its technological prowess in AI networking. With the custom chip market potentially reaching $55 billion by 2028 and Broadcom’s current leading position, the company seems well-equipped for ongoing outperformance.
But There Are Risks
While Broadcom displays strong growth prospects, several factors could restrict its upside.
- Potential Headwinds
- A considerable risk arises from its customer concentration, as dependency on a few major clients creates vulnerability.
- Increased competitive pressure from companies such as Marvell, along with possible new entrants into the market, could compress Broadcom’s margins.
- Moreover, any slowdown in AI infrastructure expenditure would disproportionately affect Broadcom’s growth outlook.
- Macroeconomic Vulnerability
- Broadcom’s stock has exhibited lower resilience during unfavorable market conditions compared to the overall market.
- For example, during the inflation shock in 2022, AVGO stock decreased by 37% while the S&P 500 fell by 25%.
- Similarly, during the correction triggered by the COVID-19 pandemic, AVGO faced a 48% drop against the benchmark index’s 34% decline. See – Buy or Sell Broadcom Stock for more details.
- This historical performance underscores the stock’s susceptibility to macroeconomic uncertainty.
Consequently, investors considering Broadcom should carefully evaluate these risks. At Trefis, we incorporate such risks into our construction of the High Quality (HQ) Portfolio, which encompasses 30 stocks and has consistently outperformed the S&P 500 over the last four years. What explains that outperformance? HQ Portfolio constituents tend to provide higher returns with lower volatility than the benchmark, as demonstrated in HQ Portfolio performance metrics.