Broadcom's Bet on AI Makes It a Top Dividend Stock for the 2020s

The hype surrounding generative AI has helped lift the shares of semiconductor giant Broadcom (AVGO 1.64%) in recent months. Its business has continued expanding even during a nasty slowdown for much of the semiconductor industry, and now, optimism about Broadcom's designs for the new era of artificial intelligence has sent the stock to new all-time highs.

Some investors worry this expected jump in AI-related sales isn't sustainable. Bubble or not, though, Broadcom's business model was built for gradual growth and income. Here's why it's still a top dividend stock for the 2020s.

Broadcom's bet on AI

For starters, consider Broadcom's recently reported fiscal second-quarter 2023 results. For the period, which ended April 30, all segments with the exception of wireless grew again. Wireless is tied to the currently tough smartphone market, particularly through its long-standing connectivity chip supply agreement with Apple, which was recently extended for another few years. And with many of its peers anticipating year-over-year declines through the beginning of this summer, Broadcom is still forecasting continuous expansion.

Data source: Broadcom.

But what of this big bet on generative AI? Most of those chips are housed within Broadcom's largest segment -- networking. Two product lines, in particular, have the spotlight: Tomahawk 5 (used for network "switching," or managing the flow of data within a data center) and Jericho3AI (a GPU-to-GPU switch used to create "clusters" of chips that train new AI models).

On the earnings call, CEO Hock Tan noted that in 2022, AI chips represented about 10% of semiconductor sales (excluding the "infrastructure software" segment). This year, he said, AI is up to 15% of semiconductor sales, and by fiscal 2024 (which will conclude in October 2024), Tan's estimate is that over 25% of semiconductor revenue could come from AI. So much for AI being a bubble ready to pop at any moment. If Tan is correct, there is a sustained run of growth from generative AI coming for the next year and a half.

Earn income from AI and more

Of course, the real beauty of owning a company like Broadcom is that its chip product portfolio is ... well, broad. AI is the hot trend of the moment, but the rest of the business can steadily grow for years to come. Once the generative AI trend has played out, its other chip designs will be able to take over as the growth torch-bearers. 

Meanwhile, Tan and his executive team have built one of the most lucrative chip companies around. Its free cash flow generation continues to chug higher, which fuels dividend payments and stock repurchases.

Notes: * Q1 fiscal year (FY) 16 represents historical results for Avago Technologies Limited. The remainder of FY16, FY17, and FY18 through April 4, 2018, represent historical results for Broadcom Limited, and all subsequent periods represent historical results of Broadcom Inc. as successor to Broadcom Limited. ** Forecasted dividend.
Broadcom's fiscal year ends on or about Oct. 31. Data source: Broadcom.

In fact, the free cash flow profit margin now sits at an incredible 49% over the last reported 12-month stretch.

Data by YCharts.

Broadcom's pending acquisition of VMware (VMW) is also rooted in the chip giant's desire to grow profitably. If regulators approve the deal -- which Tan still believes will occur by this October -- the combination will create a first-of-its-kind semiconductor and enterprise software business. But once it's a part of Broadcom, Tan and company have set a target for VMware's EBITDA (earnings before interest, tax, depreciation, and amortization) to eventually reach $8.5 billion a year, compared to just $4.7 billion in 2022.

Broadcom would need to take on more debt to bridge the takeover. Nevertheless, with or without VMware, this semiconductor leader looks like a top dividend stock for the remainder of this decade. AI is fueling its next run of growth, and overall chip demand will continue to rise over the next five to 10 years.  

Trading at just under 20 times trailing 12-month free cash flow, Broadcom stock isn't nearly the steal of a deal it was just a few months ago. It still looks reasonably valued for long-term buy-and-hold investors, though. If you do buy now, consider using dollar-cost averaging and build your position over time.