During the October 6 episode of Mad Money, a caller voiced their annoyance about Broadcom Inc. (NASDAQ: AVGO) not showing much movement. In response, Jim Cramer shared his surprise at the stock’s upward trend, mentioning a conversation he had with Jeff Marks, his co-manager of the Trust. Cramer noted that Broadcom is now higher than it was following what was deemed a disappointing earnings report, suggesting that this indicates improved prospects. He advised against selling shares at this point, even though he had reduced his holdings slightly, and encouraged others to continue holding the stock.
Cramer previously questioned the market’s reaction to Broadcom’s earnings in September, suggesting that investors were overemphasizing certain aspects of the company’s outlook. Broadcom was also highlighted as one of the 10 Best AI Infrastructure Stocks to Buy for the Long Term, indicating its strength in the AI market.
Custom AI Chips Continue to Drive Growth
Broadcom’s recent fiscal third-quarter report revealed revenues of about $29.6 billion, marking an impressive 86% increase year over year. Notably, AI semiconductor revenue surged by 221% to $16.7 billion, driven by a rise in demand for specialized accelerators and networking products. Additionally, revenue from infrastructure software grew by 29%, reaching roughly $8.75 billion. This dual approach with custom chips and networking positions Broadcom favorably within AI infrastructure spending.
They generated approximately $13.7 billion in free cash flow, about 46% of total revenue, with adjusted earnings per share hitting $3.32 in comparison to GAAP earnings of $2.68. For the forthcoming quarter, management is expecting total revenue of around $34.8 billion, including $21.7 billion from AI semiconductors. These numbers suggest significant growth, although, as Cramer pointed out, the stock’s reaction has not aligned with expectations.
The Valuation Still Depends on Delivering Growth
Broadcom’s stock is currently trading at around 21.7 times forward earnings, which is higher than the 19.6 times for NVIDIA, the leading semiconductor company. In terms of forward sales, Broadcom is at approximately 11.5 times, compared with NVIDIA’s 10.7. While NVIDIA serves as a useful reference point, it’s important to remember that Broadcom’s mix of revenue from infrastructure software and semiconductors creates a different landscape. Thus, Broadcom does not present a clear undervaluation relative to NVIDIA.
Broadcom identifies several business risks, notably fluctuations in orders from major clients and reliance on a small number of suppliers. Outsourced manufacturing further complicates things, as it necessitates precise demand forecasting and effective production capacity management. Likewise, margin expectations are crucial. The fourth-quarter guidance for adjusted operating margins is around 66%, slightly down from the previous quarter’s calculated margin of approximately 67.9%. This shows that higher sales don’t always guarantee improved margins in every instance.
Hedge Fund Participation Remains Broad
As reported by Insider Monkey, 170 hedge funds held shares of Broadcom in Q2, a slight decrease from 173 in Q1. Fisher Asset Management led with 15.13 million shares among the more than 1,000 hedge funds tracked. The short interest in Broadcom stands at 1.11% of the float, pointing to limited short positions relative to available shares.
Despite having collected some profits, Cramer is still holding onto the remaining shares. The company’s performance in AI and its robust cash flow likely contribute to that decision. However, with the stock priced higher than NVIDIA based on projected metrics, the upcoming earnings reports will need to support growth expectations.
While Broadcom has potential as an investment, I think there might be other AI stocks out there that offer more upside and less downside risk. If you’re interested in what could be an undervalued AI stock poised to gain from current economic trends, you might want to check out our free report on the best short-term AI stock.
