4 Reasons to Buy Broadcom, and 1 Reason to Sell

Over the past five years, Broadcom's (AVGO 2.14%) stock has rallied nearly 170% and easily outpaced the S&P 500's 90% gain. It also outperformed comparable chipmakers like Texas Instruments (TXN 1.78%) and NXP Semiconductors (NXPI 3.28%).

But should investors still consider investing in Broadcom as rising interest rates and other macroeconomic headwinds rattle the tech sector? Let's review four reasons to buy Broadcom -- and one reason to sell it -- to decide.

Image source: Getty Images.

1. Impressive revenue growth

In the first quarter of 2022, Broadcom generated 76% of its revenue from its semiconductors solutions business, which sells a wide range of chips for the data center, networking, software, storage, and industrial markets.

It generated the remaining 24% from its newer infrastructure software business, which was built from its acquisitions of CA Technologies and Symantec'  enterprise security business.

Broadcom's revenue rose 16% year-over-year to $7.71 billion during the quarter, which beat analysts' estimates by $100 million and marked its sixth consecutive quarter of double-digit growth:

Data source: Broadcom. YOY = Year-over-year.

Most of that growth was driven by its semiconductor business, which experienced robust demand across the cloud, data center, and wireless markets. Apple (AAPL 0.60%) also accounted for about 20% of Broadcom's revenue in 2021, so strong sales of iPhones, iPads, and Macs -- which all use its wireless chips -- likely generated additional tailwinds.

Broadcom expects its revenue to rise 20% year-over-year to $7.9 billion in the second quarter, which easily beat analysts' expectations for 12% growth.

2. Expanding margins

Broadcom is firmly profitable by both generally accepted accounting principles (GAAP) and non-GAAP measures, and its gross and operating margins both expanded year-over-year in the first quarter.

However, its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) better reflect its long-term growth by cutting through the near-term noise. Over the past year, its adjusted EBITDA margins have consistently risen sequentially and year-over-year:

Source: Broadcom. YOY = Year-over-year.

It attributes that ongoing expansion to a better mix of higher-margin chips as well as its increased pricing power throughout the global chip shortage. The company expects to post an adjusted EBITDA margin of 62.5% in the second quarter, but it often sandbags its margin guidance. Last December, it predicted it would only generate an adjusted EBITDA margin of 61.5% in the first quarter.

3. Stable free cash flow growth

Broadcom's free cash flow (FCF) rose 13% year-over-year to $3.4 billion, or 44% of its revenue, in the first quarter of 2022. Its FCF margin has also remained comfortably above 40% over the past year:

Data source: Broadcom.

By comparison, Texas Instruments posted an FCF margin of 34% in 2021, while NXP Semiconductors ended the year with an FCF margin of just 21%.

Broadcom returns most of its FCF to its investors through buybacks and dividends. It's raised its dividend annually for more than a decade, and it currently pays an attractive forward yield of 2.8%, which is higher than Texas Instruments' 2.6% yield and NXP's 2% yield.

4. A bright outlook with a low valuation

Analysts expect Broadcom's revenue and earnings per share (EPS) to grow 16% and 27%, respectively, this year. However, its stock still looks cheap at 17 times forward earnings.

Texas Instruments, which is expected to generate slower growth than Broadcom this year, trades at 20 times forward earnings. NXP, which is expected to grow at a slightly slower rate than Broadcom, trades at 14 times forward earnings.

Broadcom's low valuation, high dividend, and robust growth rates should all make it an attractive safe haven in this challenging market.

The one reason to sell Broadcom: A cyclical slowdown

Broadcom's near-term growth rates look impressive, but it trades at a low multiple because investors are bracing for a cyclical slowdown in 2023 as macro headwinds and a resolution of the chip shortage curb the market's appetite for new chips. Once that happens, Broadcom's revenue and earnings growth will likely decelerate to single-digit levels again.

Broadcom's strengths outshine its weaknesses

Broadcom's growth could decelerate over the next few quarters, but it's weathered plenty of economic downturns before. Most of the bearish concerns also seem baked into its current valuations.

Meanwhile, it will profit from the secular growth of the semiconductor market as consumer electronics, cars, data centers, and industrial machines gobble up more chips, and its infrastructure software business will continue to flourish as large organizations scale up their data centers and cybersecurity services.

Therefore, I believe Broadcom is still a solid investment for long-term investors who can tune out the near-term noise.