Is It Time to Sell Broadcom Stock?

Broadcom (AVGO 3.84%) has been an epic investment, and not just for those shareholders who have gotten more acquainted with the business in the last year of artificial intelligence (AI) hype. Broadcom's share prices soared more than 2,500% in the last 10-year period, obliterating average semiconductor industry returns for longtime shareholders (of which I'm a very happy one).

Data by YCharts.

CEO Hock Tan has done a mind-bogglingly good job at acquiring tech assets that address growth markets for the semiconductor and software industries, all the while squeezing best-in-class profit margins from them. However, after an epic run-up the last couple of years, is it time to sell some Broadcom stock?

Broadcom sails through the semiconductor industry downturn

If you haven't heard, the semiconductor industry -- with the exception of data center AI chips, led by Nvidia -- has been in a brutal downturn. It all started with smartphone and PC chips in late 2022, extended to cloud and network computing equipment last year, and has now even hit the automotive (including electric vehicles) and industrial automation markets this year.

Broadcom is a hybrid semiconductor designer. It retains a little bit of manufacturing in-house (though Taiwan Semiconductor Manufacturing handles the majority of its chipmaking work), as well as a growing enterprise software lineup now led by the VMware acquisition. Its "broad" (as its name implies) tech know-how helped Broadcom stay in growth mode over the last few years.

Data by YCharts.

Q1 fiscal 2024 (the three months ended in January 2024) got the year started on a strong foot. Semiconductor segment sales were up 4% year over year. And even backing out the inclusion of VMware, which was acquired late in calendar year 2023, Broadcom's software segment is heating up again too (due to existing customer upsells using the VMware assets). Management appears to be sitting on yet another run of positive financial gains.

Data source: Broadcom. YOY = year over year. 

This is of course saying nothing of the AI chip sales, which is what has the "networking" segment (in the table above) in high-growth mode right now. Again, that's with a big helping hand from TSMC. Broadcom is, nevertheless, an absolute beast. There's seemingly nothing slowing down its gradual rise.

It's all about the free cash flow

Over the years, shareholders have grown accustomed to huge free-cash-flow (FCF) paydays from Broadcom, with FCF profit margins approaching or exceeding an incredible 50% rate. Due to the purchase and integration of VMware, the FCF margin in the last quarter dipped to "only" 39%.

Expect that figure to steadily tick higher this coming year and beyond, as Tan and his management team are motivated to unlock not just growth synergies with VMware, but also higher profit from the big cloud software provider. Higher FCF will be important to pay down the debt Broadcom took on to make the purchase. At the end of January, Broadcom had $11.9 billion in cash and short-term investments, but $73.5 billion in debt -- although it did pay down an additional $2 billion in debt subsequent to the end of the quarter.

That said, shares do trade for 30 times trailing-12-month free cash flow, which is a premium for a business with this much debt that needs to be paid off. However, if Broadcom's overall revenue keeps chugging higher, and profit margins expand, it will be in good shape. I don't think this is the most timely semiconductor stock buy right now, but it certainly isn't a sell either. This remains a top company to hold for long-term investors.