You Can Still Buy This Value Stock Cheap

Shares of chip design giant Broadcom (AVGO 2.02%) have outperformed the broad market for years. As of this writing, the stock is up 60% since the start of 2020 and almost 200% over the last five years. Broadcom has more than just endured the start of the U.S.-China trade war, an ensuing downturn in global hardware spending, and the COVID-19 pandemic -- it's thriving.

In spite of the strong run for this tech titan (which has a current market cap of $207 billion), the stock can still be bought at a reasonable value, especially if you're looking at the long-term potential for the semiconductor industry. 

Image source: Getty Images.

Broadcom's two business lines are steady performers

During its fiscal 2021 third quarter (the three months ended Aug. 1, 2021), Broadcom reported a 16% year-over-year increase in revenue to $6.78 billion. The bread-and-butter semiconductor segment led the charge, up 19% from a year ago to $5.02 billion (about three-quarters of total sales). Software (made up of the acquisitions of Brocade, CA Technologies, and Symantec's enterprise security segment over the last few years) rose 10% to $1.76 billion, continuing Broadcom's run as a top software infrastructure management solution and one-stop shop for customers utilizing the company's data center, mobile, and networking chips.

With the first nine months of fiscal 2021 now in the books, Broadcom's business continues to chug higher and bring in both record sales and profits. And with the digital world -- especially cloud computing and all the infrastructure needed to support it -- growing increasingly important, Broadcom's momentum should last for many years to come. 

Data source: Broadcom. YOY = year over year, pp = percentage point.  

Lots of debt, but lots of free cash flow too

But is Broadcom really all that cheap? After all, the stock trades for 37 times trailing 12-month earnings per share. It also has total debt of $40.5 billion, offset by cash and equivalents of just $11.1 billion. From that standpoint, this is hardly a healthy-looking bet on the semiconductor industry. 

But then again, the company is generating ample free cash flow. In fact, its free-cash-flow margin is at a whopping 49% over the last year, and that includes the period last summer when the chip sector was reeling from the initial effects of the pandemic. From that perspective, Broadcom stock trades for a meager 16 times trailing 12-month free cash flow, a great value for this proven long-term winner. 

But why the discrepancy between earnings and free cash flow? It all has to do with those aforementioned software acquisitions. Broadcom reports lots of non-cash expenses related to the amortization of the purchases from a few years back, to the tune of $4.14 billion so far this year. The purchases are already paid for (as reflected in the sizable load of debt), but for tax reporting purposes, the expense is amortized over time and reflected in earnings per share. As the company gets some distance between the acquisitions, net earnings and free cash flow will gradually converge. 

In the meantime, Broadcom is a cash-generating machine, and it has ample ability to service its debt as well as dole out plenty more via its dividend (currently yielding 2.8%) and share buybacks. Between the two, Broadcom has shelled out $5.68 billion in shareholder returns so far in 2021 ($4.65 billion for dividends and $1.03 billion in stock repurchases), which has been handily covered by the $9.87 billion in free cash flow generated. Management forecasts sales will be up another 14% year over year in the current quarter with profit margins coming in similar to where they've been as of late.

This isn't a perfect chip business. The large debt burden in particular could be a concern down the road. But Broadcom is highly profitable, still growing at a brisk pace, and able to reward investors with a lucrative dividend payment even while managing the debt it took on to add software to its ecosystem. Riding multiple secular trends in the tech sector, Broadcom is still a great value on a long-term bet in the semiconductor space.