2024 has gotten off to a sizzling start in the capital markets. Both the S&P 500 and Nasdaq Composite have soared to record levels. Make no mistake about it -- both indexes are rising on the heels of a euphoric narrative surrounding artificial intelligence (AI).
The thing with AI is that it can take many forms. From machine learning to big data analytics, AI has an evolving number of use cases. One of the prominent pillars of the AI revolution are semiconductor chips. Companies such as Nvidia and Advanced Micro Devices are leading the charge in high-performance graphics processing units (GPUs) and data center services.
But outside of these two giants lay a number of other players in the chip space. Broadcom (AVGO 3.84%) has also garnered a lot of attention, with many analysts on Wall Street calling for further upside. Given the rocket ship Nvidia is currently on, is now a good time to look for other opportunities in the chip space such as Broadcom? Let's take a look.
How is Broadcom different?
There are many aspects to the semiconductor industry. Nvidia and AMD are known for designing GPU chips that are used for a number of generative AI applications, such as accelerated computing or training large language models (LLMs).
On the other hand, Super Micro Computer is more of an IT architecture solution, helping Nvidia build storage clusters and server racks. Lastly, there are fabrication specialists like Taiwan Semiconductor Manufacturing, which helps Nvidia actually bring its chips to life through a specialized manufacturing process.
Broadcom is different. The company specializes in networking solutions -- an area that has applications in carrier networks, both cloud-based and on-premises data centers, as well as hardware including routers or mobile devices.
Image source: Getty Images.
How AI is shifting the narrative
For the first quarter of fiscal 2024, ended Feb. 4, Broadcom increased its revenue 34% year over year to $11.9 billion. Before getting too excited, it's important to note that this year's growth includes contributions from VMware, which Broadcom acquired last year.
Broadcom's semiconductor business reported $7.4 billion in sales for the quarter, up a modest 4% annually. While this level of growth may be mundane for some, commentary from management likely encouraged investors. Within semiconductors, $2.3 billion was attributed to AI-driven sales -- up more than fourfold year over year.
Additionally, back in December management forecast that about a quarter of total semiconductor business would be attributed to artificial intelligence (AI) this year. But following the first-quarter report, management is now calling for 35% of semiconductor revenue to stem from AI -- totaling $10 billion this year.
Is the valuation compelling?
The chart below benchmarks Broadcom against a cohort of businesses operating in the semiconductor realm on a price-to-sales (P/S) basis. At a P/S multiple of 15.2, Broadcom is in the middle of this peer group.
AVGO PS Ratio data by YCharts
But like many of its semiconductor counterparts, shares of Broadcom have soared -- rising 110% over the last year. I think even though Broadcom's surface level growth may not catch your attention, it's clear that the secular demand fueling the broader semiconductor market is a bellwether for the company's largest revenue stream. This could lead to significant gains in the long run as the AI narrative takes shape.
It's this dynamic that has Wall Street raising price targets. Analysts from Benchmark, J.P. Morgan, Rosenblatt Securities, Citigroup, and Goldman Sachs all see upside in the range of 10% to even 25% from Broadcom's current trading levels.
It's nice to see such consensus among Wall Street institutions. But analyst upgrades are not reason enough to buy a stock. If anything, the myriad price target increases could cause Broadcom stock to experience some momentum -- which is always risky to follow.
I see Broadcom as a nice hedge to other semiconductor stocks or AI positions you may have. If you are looking to bolster your allocation in chip stocks or artificial intelligence (AI) opportunities, Broadcom may be a suitable option that is likely overlooked compared to Nvidia. Employing a long-term mindset and using dollar-cost averaging is a good way to build or add to a position, while keeping some of the risk insulated.
