Broadcom: Strong Pick In Semiconductor Industry (NASDAQ:AVGO)

Introduction

As a dividend growth investor, I search for new investment opportunities in income-generating assets. I take advantage of market fluctuations by adding to my existing positions when undervalued and initiating new positions to diversify my portfolio and increase my dividend income with minimal capital investment.

In the information technology sector, semiconductors are an exciting investment due to their high demand and potential for growth in various fields. In this article, we will take a closer look at Broadcom (NASDAQ:AVGO), one of the leading companies in the semiconductor industry, analyzing its strengths and potential risks as an investment opportunity.

I will analyze the company using my methodology for analyzing dividend growth stocks. I am using the same method to make it easier to compare researched companies. I will examine the company’s fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it’s a good investment.

Seeking Alpha’s company overview shows that:

Broadcom designs, develops, and supplies various semiconductor devices focusing on complex digital and mixed signal complementary metal oxide semiconductor-based devices and analog III-V-based products worldwide. The company operates in two segments, Semiconductor Solutions and Infrastructure Software. Broadcom Inc. was incorporated in 2018 and is headquartered in San Jose, California.

Fundamentals

Broadcom has experienced significant revenue growth over the last decade, with revenues increasing by more than 1300%. This growth can be attributed to a combination of both organic and inorganic growth strategies. The company’s commitment to research and development has contributed to its organic growth. Additionally, Inorganic growth has significantly contributed to the company’s success, with acquisitions playing a pivotal role. Broadcom’s pending acquisition of VMware (VMW) is a prime example. It is expected to expand the company’s software portfolio, increase its revenue streams, and make it more resilient to market fluctuations. In the future, as seen on Seeking Alpha, the analyst consensus expects Broadcom to keep growing sales at an annual rate of ~5% in the medium term.

Broadcom’s EPS (earnings per share) has grown significantly over the last decade, increasing over 1000%. This growth is connected to the company’s revenue growth and its ability to improve margins through synergies from acquisitions. As the company’s revenue has grown, so has its EPS, reflecting its ability to generate consistent earnings growth. In the future, as seen on Seeking Alpha, the analyst consensus expects Broadcom to keep growing EPS at an annual rate of ~7% in the medium term.

The dividend’s profile is unique to Broadcom. The company pays an attractive 3% dividend which has grown at a CAGR of 38% over the last decade, with a growth streak of twelve years. The current dividend growth rate is not sustainable, as the payout ratio has reached 61%. Therefore, in the future, investors should expect the growth rate to be in line with the average EPS growth rate or about 10%, so the company doesn’t stretch the payout ratio too much.

In addition to dividends, companies tend to return capital to shareholders via buybacks. These share repurchase plans support EPS growth as they lower the number of outstanding shares. Broadcom is buying back its shares, yet the number of shares is still growing. It issues shares with funding acquisitions and with paying its employees. Over the last decade, the number of shares has increased by almost 70%, and the company showed significant growth despite its shareholders’ dilution.

Valuation

Looking at the 2023 forecasted EPS, Broadcom’s P/E (price to earnings) ratio is currently at 13.9, which is considered attractive for a growing company. With a P/E ratio of 13.9, Broadcom is presently trading at a reasonable valuation, which is appealing for a growing company. While the P/E ratio may have been lower several months ago, it’s still considered attractive considering the company’s growth prospects.

The graph below from Fastgraphs also emphasizes that the current valuation is in line with the average valuation we have seen over the last two decades. In the past twenty years, the average P/E ratio of the company was 14.6, which is higher than the current forward P/E ratio. While the forecasted growth rate is lower than the historical CAGR of 30%, it is still a decent valuation for a growing company.

Broadcom has solid fundamentals and is currently fairly valued. The company’s strong financial performance and commitment to growing organically and inorganically make it a stable company. Broadcom is trading at a reasonable valuation with a P/E ratio of 13.9 and a history of consistent earnings growth. It’s essential to consider the growth opportunities and risks to determine if this reliable company is an attractive investment.

Opportunities

Broadcom enjoys significant diversification due to its acquisitions, which allows it to be a player in several prominent industries. The growing demand for cloud technology is one of them. Broadcom can benefit from cloud migration even before the VMware acquisition. As more businesses and organizations move their operations to the cloud, the demand for cloud infrastructure and management solutions is expected to grow significantly. Broadcom provides the necessary products needed for data centers, servers, and enterprise cloud making the company well-positioned to capture a share of this growing market.

Another reason to invest in Broadcom is its presence in the EV (electric vehicle) and IoT (Internet of Things) markets. The adoption of electric vehicles is expected to increase significantly in the coming years, driven by government regulations and consumer demand for more sustainable transportation options. Broadcom’s expertise in power management and sensor technology positions the company well to benefit from the growing demand for EV components and systems. Broadcom’s IoT solutions can also optimize EV charging infrastructure performance and improve the overall industrial automation trend.

Another reason to consider investing in Broadcom is the company’s excellent capital allocation strategy. The company has a history of significant mergers and acquisitions. The recent pending acquisition of VMware can be another success story. VMware is a leading provider of virtualization and cloud infrastructure solutions, and the acquisition is expected to significantly expand Broadcom’s presence in the software and cloud computing markets. Businesses of all sizes widely use VMware’s solutions, and the acquisition gives Broadcom access to a large and growing customer base. Additionally, the acquisition is expected to create significant synergies and cost savings for the combined company.

Risks

One potential risk to consider when investing in Broadcom is the company’s debt level, which could become a concern in a higher interest rate environment. As interest rates rise, the cost of borrowing increases, which could increase interest payments and affect its financial performance. Additionally, a higher interest rate environment could make it more challenging for the company to raise capital through debt offerings, limiting its ability to invest in new products and services or make acquisitions.

Another risk is the possibility of significant customers, such as Apple (AAPL), developing their semiconductors. Apple is one of Broadcom’s largest customers, and the company has started developing its semiconductors. It may reduce the demand for Broadcom’s products and services. It could significantly impact the company’s revenue and financial performance, making it a potential risk to consider.

The competition in the semiconductor market is intense and can be a risk for Broadcom. The company faces competition from prominent established players and smaller, more nimble competitors. Some of these competitors have significant resources and expertise, which can make it difficult for Broadcom to maintain its competitive advantage. The risk of competition can be intensified if we enter a recession. Economic downturns can lead to a decrease in consumer and business spending, negatively impacting the demand for semiconductors. When there are many offerings, such as in the semiconductor business, it may reduce the price.

Conclusions

Broadcom has strong fundamentals, fair valuation, decent growth opportunities, and manageable future risks. The company’s strong financial performance, commitment to R&D, presence in growing markets such as electric vehicles and IoT, and its pending acquisition of VMware, position it well for future growth. Additionally, the company’s P/E ratio of 13.9 and history of consistent earnings growth make it an attractive investment opportunity.

Broadcom’s solid fundamentals and growth prospects, manageable risks, and decent valuation make it a solid investment choice for long-term growth. Therefore, I believe Broadcom is a BUY as it has what it needs to keep growing organically and inorganically. It will be a STRONG BUY if its P/E ratio reaches 12, which means a price of ~$490 at the current EPS estimates.