Shares of chip giant Broadcom (AVGO 2.66%) are having a great year. The stock price is up 46% over the last 12-month stretch -- including up 10% so far in 2021 -- as the global chip shortage is sending sales higher. The dividend Broadcom offers sweetens the deal, currently yielding 3% a year. But there's more left in the tank.
The company's latest quarterly earnings report paints a rosy picture for this tech stock's performance in 2021. Here are three reasons why shares, despite their relatively high price, are still dirt cheap.
1. A rebounding semiconductor business
During the fiscal 2021 second quarter (the three months ended May 2, 2021), total revenue increased 15% year over year to $6.61 billion. Driving this increase was a 20% rise in semiconductor sales, which make up about three-fourths of Broadcom's business.
Image source: Getty Images.
Broadcom is lapping effects from multiple headwinds right now, including depressed sales during the start of the pandemic and lingering effects from the U.S.-China trade war that began a couple of years ago. But now chips Broadcom specializes in are in high demand, especially for mobile phones (including for 5G mobility), data centers, business networking equipment, and automotive tech. CEO Hock Tan said to expect a Q3 rate of growth similar to that in Q2 for its chip segment as demand remains strong.
Though it's already a mammoth in the semiconductor industry, Broadcom is growing faster than many of its peers right now. The stock is a top buy in the tech hardware space, as the chip shortage is helping Broadcom inch closer to all-time high component sales last achieved back in 2018.
2. Highly profitable software services are still on the rise
Though its semiconductor solutions segment is rallying, Broadcom overall has continued to grow in the last few years. That's thanks to a few acquisitions -- namely, of infrastructure management software outfits Brocade Communications, CA Technologies, and the enterprise security segment of Symantec (the rest of which now goes by NortonLifeLock).
This infrastructure software is complementary to Broadcom's chip business as it will often bundle the services when it sells components to data center and network operators. The company has been right-sizing this business, though, offloading smaller and low-profit accounts. Even so, infrastructure software sales increased 4% year over year in the last quarter to $1.79 billion. This is an important area for Broadcom since software has higher gross profit margins than semiconductors do. In fact, because of these acquisitions in the last few years, Broadcom's overall gross profit margin was 61% in fiscal Q2, compared to 56% a year ago and just 54% at the end of fiscal 2018.
Steady software growth paired with rallying chip sales means Broadcom's bottom-line will likely grow at an even faster rate for the remainder of this year.
3. An incredible cash-generating machine
Broadcom reported a 28% increase in net income in Q2 to $2.98 billion and free cash flow of $3.44 billion. That equates to an incredible free cash flow profit margin of 52%.
Broadcom uses this cash flow to fund its dividend, which cost $1.55 billion in the last quarter -- less than half of free cash flow generated. That leaves ample room for the company to spend on research and development, make future acquisitions, and increase its shareholder payout over time. And given the revenue growth management is expecting for the foreseeable future, free cash flow will keep rising. Shares currently trade for just under 15 times trailing 12-month free cash flow.
After its latest quarterly update, Broadcom stock looks cheaper than ever and is one of my top buys in the semiconductor industry right now.
