Broadcom’s most interesting number this quarter was not its earnings per share. It was the speed at which customers bought more of its custom AI chips. Management reported AI semiconductor revenue of $16.7 billion, a 221% increase from the previous year. Just three months earlier, the same business had brought in $10.8 billion. Broadcom Inc. (NASDAQ:AVGO) is benefiting from the expansion of AI computing without having to build the data centers itself. Whether customers can keep spending at this pace is another matter.
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Bull Case
The semiconductor story is no longer confined to a handful of promising contracts. Broadcom Inc. (NASDAQ:AVGO) reported Semiconductor Solutions revenue of $20.839 billion for its fiscal third quarter, compared with $9.166 billion a year earlier, with CEO Hock Tan attributing the AI acceleration to demand for custom accelerators and networking. Custom chips give Broadcom a distinct role in a market, as its custom AI accelerators and networking continue to drive very strong demand.
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The wider company is turning those sales into money shareholders can measure. Total quarterly revenue reached $29.6 billion, against $15.952 billion a year earlier. GAAP operating income rose to $15.955 billion, up from $5.887 billion compared to the prior year period. Operating cash flow reached $14.197 billion, and Broadcom reported $ 13.665 billion of free cash flow after capital expenditures. The comparison with companies investing heavily to operate AI infrastructure is revealing, as Broadcom reports strong cash generation while supplying chips and networking equipment to them. Read more about AVGO’s bull and bear case here.
VMware also deserves space in the investment argument. Infrastructure Software brought in $8.752 billion, versus $ 6.786 billion in the prior-year quarter. It is growing more slowly than semiconductors, but it provides a separate revenue source within a business that investors increasingly associate almost entirely with AI hardware. Broadcom has also introduced VMware products designed for enterprise AI deployment, and while announcing those tools does not establish their future financial contribution, the reported software revenue is the firmer evidence.
Bear Case
There is a reason not to extrapolate this quarter indefinitely. AI-related semiconductor revenue is growing faster than the rest of Broadcom Inc. (NASDAQ:AVGO), making the company’s performance more exposed to a sustained investment cycle among AI infrastructure buyers. Management expects $21.7 billion of AI semiconductor revenue next quarter, up 236% year-over-year. That is a forecast, not revenue already earned, and it makes the next set of results unusually consequential.
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The earnings presentation deserves care too. Broadcom reported $20.095 billion of non-GAAP operating income, considerably higher than GAAP operating income of $15.955 billion. Its reconciliation excludes $2.019 billion of stock-based compensation expense as well as acquisition-related amortization and other items.
Valuation
Yahoo Finance’s latest available valuation data lists Broadcom at 19.42 times forward earnings compared with a trailing P/E of 46.50x, suggesting that expectations for future earnings growth are considerably stronger than recent earnings alone would indicate. The company’s earnings provide evidence for the optimism. Management’s forecast of $21.7 billion in fourth-quarter AI semiconductor revenue reinforces expectations of further growth, but it also raises the earnings bar.
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At 19.42 times forward earnings, the shares may appear relatively inexpensive compared with their trailing multiple, yet that comparison offers limited comfort if future chip orders fail to support the profits embedded in forward estimates.
Conclusion
Broadcom Inc. (NASDAQ:AVGO) does not need to prove that customers want AI hardware since its latest revenue already demonstrates that demand. Investors have a tougher job. They must distinguish an exceptional period of infrastructure purchases from earnings that can be sustained once the pace of expansion changes. Broadcom’s software revenue and strong free cash flow give that assessment more substance than chip growth alone, but neither provides certainty about future orders.
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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This article is originally published at Insider Monkey.
