Stock of the week - Broadcom (20.06.2024)

• Broadcom trades at all-time highs
• Strong fiscal-Q2 earnings release triggered another upward impulse on the stock
• Biggest single-day jump since March 2020
• VMware acquisition and AI drives strong results
• Upbeat full-year forecasts issued
• Company announced 10-to-1 stock split
• A look at valuation

Broadcom (AVGO.US) has been one of top performers among US large-caps over the past week or so. Stock gained around 25% since fiscal-Q2 earnings release on Wednesday, June 12, and moved to fresh all-time highs. Recent VMware acquisition as well as strong demand for AI products continues to be a driver of company's earnings. Let's take a closer look at recent news on the company and its valuation.

Broadcom rallies to fresh all-time highs

Broadcom has been enjoying strong gains recently. While the stock has been on the rise for a long time now, gaining over 300% since October 2022 lows, the most recent upward impulse was triggered by release fiscal-Q2 2024 results on Wednesday last week. Earnings release triggered a 12.5% jump in company's stock, which was the largest single-day share price jump since March 2020. Stock continued to move high in the next days as well and finished Tuesday's trading over 20% above pre-earnings levels. Stock reached fresh all-time highs above $1,800 per share mark and is trading around 60% year-to-date higher. 

Source: XTB Research

VMware acquistion and AI drives strong results

The aforementioned fiscal-Q2 results, that triggered the new upward impulse on the stock, were very upbeat. Broadcom reported a 43% YoY jump in revenue during the quarter, led by strong growth in Infrastructure Software revenue. However, this segment was boosted by the acquisition of VMware, cloud computing company, in late-2023 and Broadcom said that excluding the impact of VMware, growth would be just 12% YoY. Company said that it expects VMware acquisition to continue to improve company's results and analysts hint that there is a room for further integration and synergies.

This is also reflected in new full-year fiscal-2024 forecasts. Company expects full-year fiscal-2024 revenue to reach $51 billion, what would result in an over 42% growth compared to fiscal-2023. Broadcom expects adjusted EBITDA margin to reach 61% in full fiscal-2024, an improvement from 57.6% reported for full fiscal-2023.

Apart from VMware acquisition, increased demand for AI products is also supporting company's business. Revenue from AI products in fiscal-Q2 2024 reach $3.1 billion - a new record high.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

10-for-1 stock split announced

Apart from reporting much better-than-expected fiscal-Q2 2024 results, Broadcom has also announced a 10-for-1 stock split. Trading in company's share on a post-split is scheduled to begin on July 15, 2024. Stock splits themselves have no impact on investors' holdings - 10-for-1 stock split means that company's shareholders will have ten times more shares, but each with a ten times smaller price.

Aim of splitting stock is to make it more accessible for investors, as shares with lower price tag will be more affordable to traders. However, this argument has lost some of its rationale after fractional trading was introduced. A recent well-known examples of what happens after stock split is made are inconclusive to its impact - Tesla's stock split in 2022 marked local high while Nvidia continued to gain after its recent split. 

However, it should be noted that Tesla fundamentals and prospects began to deteriorate, while outlook for and sentiment around Nvidia remained strong.

A look at valuation

Recent rally on Broadcom has been impressive, but one may wonder - did the stock got ahead of its fundamentals? Let's take a look at Broadcom's valuation using three often used valuation models - Discounted Cash Flow method, Peer Comparison and Gordon Growth Model. 

We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices. 

Discounted Cash Flow method

Let's start with one of the most popular fundamental models - Discount Cash Flow method (DCF). This model relies on a number of assumptions, including assumptions on sales growth and margins. Broadcom has been experiencing strong growth in recent quarter and years, with AI demand helping the company and being expected to continue to help. We have decided to take an aggressive approach in valuing the company in order to capture growth potential coming from AI. We have decided to assume 20% revenue growth and 45% operating margin. Remaining variables were based on 5-year averages. We have assumed a 5% terminal revenue growth rate and 9% terminal weighted average cost of capital (WACC). Detailed forecast for 5 years were made, followed by terminal forecast. Using such a set of assumptions leads us to DCF valuation of $2374.88 per Broadcom's share - or over-30% above Tuesday's cash close. 

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, let's take a look at how Broadcom's valuation compares with its peers. We have created a peer group consisting of companies that are operating in one or more similar branches as Broadcom. Group includes - Qualcomm, Advanced Micro Devices, Super Micro Computer, Micron Technology, Microchip Technology, Analog Devices, Texas Instruments. We have take a look at a number of multiples, including trailing and forward multiples. Multiples as well as mean, median and cap-weighted averages for the group can be found in the table below.

As one can see, there is quite significant volatility in multiples for Broadcom's peers. In almost every case valuations based on mean and median multiples are suggesting that Broadcom is overvalued at current prices. Cap-weighted multiples also suggest overvaluation of company's stock compared to peers. In fact, only cap-weighted P/E, mean P/FCF and cap-weighted P/FCF suggest that there is still an upside for the stock.

Source: Bloomberg Finance LP, XTB Research

Gordon Growth Model

Last but not least, let's take a look at Broadcom's valuation using Gordon Growth Model. This model is based on dividends and as Broadcom is a dividend-paying company, it can be valued using this method. We have decided to base required rate of return on 5-year average cost of equity of 11%. Terminal dividend growth forecast was set at 10%, lower than indicated by 5-year average, although more probable to be maintained over long-term. Such a set of assumptions provides us with an intrinsic value of Broadcom's share of $2,310 per share - or around 25% above current market prices.

However, it needs to be said that Gordon Growth Model is very sensitive to assumptions. Lowering the dividend growth assumption by just 30 basis points would lead to a below-market valuation of Broadcom's shares, and so would a 30 basis points increase to required rate of return assumption.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

As we have already mentioned earlier, Broadcom (AVGO.US) jumped to fresh all-time highs following release of fiscal-Q2 2024 results. As the stock trades in uncharted waters, technical analysis is becoming less and less helpful in determining potential resistance levels. Sentiment towards the stock remains strong and further gains cannot be ruled out. According to 14-day RSI indicator, the stock has been the most overbought in over a year. However, it should be said that back in late-May 2023 when company's RSI indicator pulled back from a level similar to today's, it did not lead to any major correction on the stock. In fact, situation is now somewhat similar to that - Broadcom stock rallied over 20% in a matter of 3 days in late-May 2023 in response to solid earnings of AI-related companies, like for example Nvidia, and then started to trade sideways. However, this sideways move was brief and stock resumed gains.

Source: xStation5