Nvidia (NVDA 2.13%), Advanced Micro Devices (AMD 0.79%), and Broadcom (AVGO 2.82%) have been some of the hottest semiconductor stocks over the last couple of years. But recently, the artificial intelligence-fueled rally has cooled, sending Nvidia down 17% from its all-time high, Broadcom down 18%, and AMD down 35%.
Let's determine whether the sell-off is a buying opportunity, or if these growth stocks ran up too far, too fast.
Image source: Getty Images.
A market leader worthy of pole position
Over the last three years, Nvidia's stock price rose a mind-numbing 474%. But its diluted earnings per share (EPS) is up an even better 509%. So, on the surface, Nvidia's massive run-up seems overextended, but the business has largely backed up the rally by growing earnings. The question now is whether the growth is sustainable, and what a reasonable valuation for the stock is.
Nvidia's earnings growth is attributed to a change in revenue mix. In past years, Nvidia generated most of its revenue from gaming, chips for personal computers, software for internet applications, visualization, and more. It was a solid business, but nothing like the Nvidia of today.
In fiscal 2024, 84.5% of revenue came from Nvidia's Compute and Networking segment, which includes graphics processing units (GPUs) that can handle AI workloads. Five years ago, in fiscal 2020, Compute and Networking comprised less than a fifth of total revenue.
Nvidia's business is almost unrecognizable from just a few years ago. The company could continue growing earnings at a breakneck pace, as long as there's sustained demand for AI systems and Nvidia maintains its market share.
Surprisingly, Nvidia's price-to-earnings (P/E) ratio isn't high compared to historical levels. Even better, its forward P/E is just 41, implying strong earnings growth expectations over the next year.
NVDA PE Ratio data by YCharts.
Nvidia is a good example of why a stock isn't necessarily expensive just because its price has increased. Nvidia is a phenomenal company that is flat-out delivering results for investors.
The biggest concern with Nvidia is that growth will slow during a cyclical downturn, or that it'll work through its backlog and see lower demand. After all, a lot of its customers have raced to buy AI chips, but it remains to be seen if their repeat purchases will be as large. There's also the concern that Nvidia's pricing power will erode as competition grows -- which could lead to slowing growth or lower profit margins.
Nvidia isn't expensive right now. The stock could begin to look cheap if the AI investment flurry continues. But it's uncertain what Nvidia's market share will look like a few years from now and how much pricing power it will have in this new competitive landscape. Therefore, an investment in Nvidia should only be considered if you have a high risk tolerance.
NASDAQ: NVDA
Key Data Points
Expectations are high for AMD to post record profits
AMD often gets compared to Nvidia. But the companies have noticeably different revenue mixes. While AI chips now dominate Nvidia's business, AMD still makes most of its revenue from other sources.
Data center revenue grew 80% in first-quarter 2024 compared to first-quarter 2023. But even then, it still made up just 43% of total revenue. AMD's PC chip segment has staged a massive recovery and is contributing to overall results. Demand for AI chips in PCs is a big growth driver for AMD. And there's reason to think AMD's MI300 GPU will experience sustained high demand as customers look for alternatives to Nvidia's lineup, given the high prices and wait times.
AMD is harder to value than Nvidia because it is chock-full of potential but also doesn't have the proven results -- yet. The biggest near-term risk to AMD is that its investments will take longer to pay off due to slowing demand or an industry-wide downturn.
AMD's research and development (R&D) expense as a percentage of revenue has climbed to 26.3% -- a 10-year high. R&D spending is par for the course in innovative industries, but AMD has to prove to investors that its investments will lead to earnings growth.
Analyst expectations are fairly high for AMD -- with 2024 consensus EPS at $3.50 and then $5.53 in 2025. For context, AMD earned just $0.53 in EPS in 2023 -- mostly because it has been focusing on R&D and sales growth. But even then, its 10-year-high EPS was $2.57 in 2021.
AMD is set to continue growing its core business and carve out a sizable chunk of AI chip market share. If it does deliver on those 2025 earnings goals, the stock could look inexpensive. AMD is a riskier bet than Nvidia, but it can potentially produce better gains going forward.
NASDAQ: AMD
Key Data Points
The most balanced player in a growth industry
Broadcom embodies the old saying: "When there's a gold rush, sell picks and shovels." Put another way, a company doesn't have to profit from the AI boom by selling GPUs. The infrastructure and software solutions company makes chips and hardware for smartphone makers, internet companies, data centers, and cloud-based tools through its subsidiary, VMware.
Broadcom doesn't make GPUs like Nvidia. Rather, it provides essential hardware for IT infrastructure and hyper-scale data centers that demand increasingly higher computational power. For example, Broadcom provides network, server, and storage connectivity for data centers -- from ethernet switches to adapters, controllers, and more.
The company expects generative AI to accelerate growth in its chipmaking business. Generative AI is already responsible for a fifth of semiconductor revenue, and that business unit makes up 79% of total revenue. Broadcom is an exciting opportunity because generative AI currently makes up a relatively small portion of its business, and it also has plenty of other revenue streams.
In this vein, it is arguably the most diversified option in the space. It is also the least expensive stock on this list, with a forward P/E of 31.4. Broadcom pays a growing dividend that currently yields 1.3%.
The stock isn't cheap, but it isn't overpriced either. It stands out as a catch-all way to invest in sustained growth in the semiconductor industry without going all-in on AI or a particular GPU maker.
NASDAQ: AVGO
Key Data Points
Three good choices to consider now
One of my favorite quotes by Warren Buffett is, "You pay a very high price in the stock market for a cheery consensus." Put another way, popular stocks are probably going to sport premium valuations. Tech is the hottest sector in the market, and semiconductors are the hottest industry in that sector. So before even thinking about investing in the space, it's important to realize that chip stocks, at least right now, are as cheery a consensus as it gets.
A pullback in chip stocks could be good for long-term investors. Unrealistic expectations can lead to brutal corrections in companies with expensive valuations. Ideally, earnings growth, not euphoria, drives stock prices.
There's an argument that Nvidia, AMD, and Broadcom are all good buys now. For most investors, I would say Broadcom is the best overall buy because it has the most reasonable valuation and a diversified business model, pays a dividend, and doesn't have sky-high growth exceptions.
By the same token, I could also see AMD being the top performer over the next three to five years, but it may be best to take a wait-and-see approach on that company to see more defined signs that R&D investments are paying off.
