Is Broadcom Stock a Buy After Shaking Off Chip Demand Worries?

There has been a lot of noise coming from the chip industry. Many companies with outsized exposure to consumer electronics are getting hammered as work-from-home fueled spending cools off. Enterprise spending, especially on data centers and other networking gear, is holding strong.

With that as a backdrop, industry giant Broadcom (AVGO -1.18%) hit one out of the park in Q3 of fiscal 2022 (the three-month period ended in July), and management is forecasting another record quarter for its semiconductor segment to close out its current fiscal year. With the company (nearly) firing on all cylinders, is the stock a buy?

Broadcom asks, "What chip sales downturn?"

Total revenue in the last quarter was up 25% year over year to $8.46 billion. Semiconductor solutions, which represented 78% of sales, led the charge higher. The segment surged 32% year over year to $6.62 billion, while infrastructure software (the other 22% of sales) was up just 5% to $1.84 billion. 

Even better, Broadcom CEO Hock Tan said on the earnings call the company expects semiconductor revenue to jump 25% year over year in Q4 as well. For a company growing this fast, shares look incredibly cheap right now. After the earnings update, Tan's chip titan trades for just 15 times enterprise value to free cash flow.

The key to chip industry outperformance

Broadcom's results fly in the face of many other chip company results as of late, but there are good reasons why this semiconductor designer is faring better than most of the pack. Tan and his management team cited its strong presence in data centers and networking, the computing units that power cloud computing. Global economic growth is slowing, so many businesses are looking for projects with quick payoffs -- and various cloud initiatives deliver on that front. 

Data source: Broadcom. Note figures are for fiscal year 2022. YOY = year over year. 

Broadcom's portfolio of chips is often associated with the smartphone market. Some investors were worried this exposure would drag the company into cyclical decline like it has other silicon designers. However, about three-quarters of Broadcom's sales are actually to enterprises, with a particular focus on cloud and internet infrastructure. A massive tech hardware upgrade cycle is underway in this department, and it could keep Broadcom on the rise for some time. 

Is Broadcom stock a buy?

Given its position of strength in data centers and networking and cheap stock price, Broadcom is a strong semiconductor stock buy right now. But there are some things to be mindful of.

First is debt. At the end of July, the company had cash and investments of $9.98 billion, offset by debt of $39.5 billion (much of which is related to its infrastructure software acquisitions in recent years). Broadcom is in the process of acquiring cloud systems company VMWare (VMW) for a whopping $61 billion in cash and stock. About $32 billion of this price tag is expected to be financed with more debt. 

Broadcom is great as it is, but acquiring VMWare -- if the deal even gets clearance from regulators at all -- could get messy.

But this mega-merger isn't set to happen until late next year. In the meantime, Broadcom is churning out massive amounts of free cash flow (at a 51% profit margin last quarter) and buying back tons of stock. In fact, the company has authorized repurchasing up to $10 billion worth of its shares through the end of its fiscal 2023 (which ends October 2023). Add in a dividend payment currently yielding 3.3%, and this is a top income-generating investment.

Of course, the pending VMWare deal could change the dynamic here, so stay tuned for more details. However, at this juncture, I'm loading up on more Broadcom stock as it shakes off the broader semiconductor industry downturn.