The AI sell-off extended on Friday and affected stock markets around the world. Oil prices remained volatile amid the U.S.-Iran tensions. Chip stocks, in particular, took the largest hit after a poor week. There is skepticism that AI chip prices are too high and that demand for computer memory and processors would be unsustainable if AI ends up making less profit than expected. AI spending has been in question, with companies burning through capex faster than anticipated and potential returns uncertain given the scale of investments of hyperscalers.
The sector-wide AI sell-off has taken down Broadcom Inc. (NASDAQ:AVGO) as well, with the stock declining over 7% in the last week. However, AVGO is not a speculative bet; it is a company generating $10.3 billion in FCF per quarter, with $30 billion in quarterly AI bookings as of Q2 FY2026.
Investors who have an eye on the future may look into this aspect of Broadcom: AI semiconductor revenue is growing in triple digits. During Q2 FY2026, AI semiconductor revenue soared 143% year-over-year, representing 49% of the total revenue. Whereas Broadcom’s high-margin software business, which operates at 93% gross margin and has been the backbone of the company’s blended profitability, represents 32% of the total revenue and grew at just 9% year-over-year.
Why Broadcom’s Gross Margins Are on a Downward Trend
With each passing quarter, Broadcom’s software continues to offer a high-margin earnings foundation, even as its AI semiconductor business grows at a robust pace. The growth buildup around its AI semiconductor segment is remarkable. But it is creating a product mix that is statistically shrinking gross margins. Consolidated gross margins dropped to 77.1% in Q2, down 230 basis points from a year ago, and are expected to plunge further to 74% in Q3. The management explicitly identified this as a mix-shift effect, not structural margin erosion, and pointed to operating margin leverage as the offset. Interestingly, the company’s operating margins have remained steady at a record 67.3%.
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Management’s response to a thesis that Broadcom is transitioning into a pure-play AI semiconductor firm was an emphatic no. CEO Tan Hock told Citi analysts during the Q2 earnings call that AI is not disrupting software renewals; on the contrary, the high volume of CPU cores deployed alongside GPUs is accelerating VMware’s business growth. Infrastructure software revenue is expected to be around $8.9 billion for Q3, up 31% from a year ago. Tan pointed out that the company does not expect any long-term impact on its software business amid its deep integration at the hypervisor layer. However, the numbers tell you otherwise: the two segments are growing at a disproportionate level, as the software business contribution continues to grow at a lower pace.
The Bull Case: Digging a bit deeper into Broadcom’s AI semiconductor business, the company booked over $30 billion in AI semiconductor orders with $10.8 billion in shipments completed. Broadcom’s revenue visibility for the next two years is clear with long-term deals with Google through 2031 and a multi-generation MTIA XPU partnership with Meta until 2028. Moreover, the OpenAI and Anthropic contracts for 2027 are visible in the anticipated $100 billion AI revenue for FY2027. For Q3, the management projects the AI semiconductor revenue to reach $16 billion, implying more than 200% year-over-year growth. The company is targeting revenue of $56 billion in FY2026 and to cross $100 billion in FY2027.
What does this rapidly growing AI semiconductor segment mean for the margin profile for AVGO that justifies the premium multiple? The stock currently trades at a forward P/E of 19x (FY 2027), which is below the company’s five-year average of 26x, suggesting the market may not be fully pricing in the long-term earnings potential of its AI business. For investors who are inclined towards the $100 billion FY2027 target, the valuation case is stronger today than in the past five years.
The Bear Case: Broadcom’s AI revenue depends heavily on six core customers. CEO Tan, during the call, acknowledged that Google will sustain diversity of chip sources. Any hyperscaler that shifts to its in-house chips would have an immediate revenue shock. Goldman Sachs Research analyst Jim Covello shares a similar thesis. Covello argues that the AI capex supercycle is more likely to be a one-time event, and that if hyperscalers slow spending to recover FCF, Broadcom’s $30 billion quarterly bookings pace could slow meaningfully. The $100 billion AI semiconductor revenue target for FY2027 leaves little room for any execution miss or softening in demand.
One additional aspect worth noting is Networking, which accounted for almost 40% of Broadcom’s Q2 AI revenue and boasts higher margins than XPUs and is near its peak share. It is expected to trend back toward nearly 30% growth going forward, as Tan noted on the earnings call. Consequently, the cushion of high-margin networking against the XPU margin pressure will also fade over time, leading to further squeeze on gross margins.
Hedge funds appeared relatively cautious on Broadcom in late March 2026. According to Insider Monkey’s hedge fund data, 174 hedge funds held AVGO shares at the end of Q1 2026 compared to 203 funds holding the stock at the end of Q4 2025. Compared with peers, 274, 134, and 79 hedge funds held stakes in NVIDIA, AMD, and Marvell Technology, respectively.
While we acknowledge the risk and potential of AVGO as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than AVGO and that has 10,000% upside potential, check out our report about this cheapest AI stock.
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