Broadcom (AVGO +4.69%) investors got a reality check last week following the release of the company's fiscal 2024 third-quarter results (for the three months ended Aug. 4). As a result, shares of the semiconductor giant tumbled more than 10% in a single session, even though its revenue and earnings exceeded expectations. The chipmaker fell victim to Wall Street's ambitious expectations as its guidance for the current quarter couldn't match consensus estimates.
Those investors shouldn't be too upset though. Broadcom's business continues to get a nice boost from the growing demand for its custom processors and networking chips that are deployed in artificial intelligence (AI) data centers. That boost helped Broadcom's price rise nearly 81% over the past year, even after the post-earnings price drop.
NASDAQ: AVGO
Key Data Points
Let's take a closer look at Broadcom's latest results and check if investors should use its drop as an opportunity to buy an AI stock that could deliver healthy gains over the next three years.
Broadcom's results prove that it is playing a key role in the proliferation of AI
Broadcom's fiscal Q3 revenue increased 47% year over year to $13.1 billion, which was slightly ahead of the $12.98 billion consensus estimate. Its organic revenue growth (excluding the VMware acquisition that was completed in November last year) increased by 4% on a year-over-year basis. Broadcom's non-GAAP earnings increased to $1.24 per share last quarter from $1.05 per share in the year-ago period. The reading exceeded the consensus estimate of $1.22 per share.
However, Broadcom's revenue forecast of $14 billion for the current quarter didn't quite meet Wall Street's expectation of $14.1 billion. While that wasn't a huge miss, investors were quick to press the panic button as they were anticipating the growing adoption of the company's AI chips to lead to a stronger outlook.
Management comments on the latest earnings conference call provide clear evidence that AI is indeed giving the company's business a big boost. Sales of Broadcom's custom AI chips increased by 3.5 times on a year-over-year basis. Meanwhile, sales of the company's Ethernet switches increased by four times from the prior-year period, while the demand for its optical switching and interconnect offerings increased threefold.
Based on this robust demand, Broadcom now anticipates AI revenue of $12 billion in fiscal 2024, up from the earlier expectation of $11 billion. The company also increased its full-year guidance to $51.5 billion from the prior expectation of $51 billion. Broadcom hasn't raised its overall revenue outlook by $1 billion despite raising its AI revenue guidance by that margin because of the weakness in non-AI related semiconductor sales.
Broadcom's non-AI networking revenue fell 41% year over year last quarter. Similarly, the server storage connectivity business declined by 25% from the year-ago quarter. The weakness in these markets explains why Broadcom's semiconductor solutions revenue increased just 5% year over year last quarter.
However, Broadcom management said it believes that Broadcom's non-AI semiconductor business has stabilized, and a recovery is expected to begin in the current quarter. Analysts increased their revenue estimates for the next couple of fiscal years following Broadcom's latest report.
AVGO Revenue Estimates for Current Fiscal Year data by YCharts
The stock could deliver healthy gains over the next three years
Broadcom has been touted by some as the second-most important AI chip company after Nvidia thanks to its solid position in the market for custom AI processors. J.P. Morgan estimates that Broadcom could pull in a cumulative $150 billion in revenue from its AI customers over the next four to five years. Those customers include Alphabet, Meta Platforms, OpenAI, and ByteDance, as well as a fifth unidentified customer.
Broadcom's updated revenue forecast for fiscal 2024 suggests that AI will produce 23% of its top line. That proportion is likely to increase in the future considering the cumulative end-market opportunity the company is sitting on, as per J.P. Morgan. In all, a recovery in Broadcom's non-AI business along with the growth in its AI business is likely to drive an improvement in the company's growth in the future.
There was a resulting bump in Broadcom's earnings growth estimates after it released its latest earnings report.
AVGO EPS Estimates for Current Fiscal Year data by YCharts
Broadcom stock trades at 23 times forward earnings, which is a discount to the Nasdaq-100 index's forward earnings multiple of 29 (using the index as a proxy for tech stocks). So, investors can buy Broadcom at a relatively discounted valuation right now, and they may not want to miss this opportunity. If the market decides to reward Broadcom with a higher valuation thanks to its AI-driven growth, it could deliver healthy gains in the future.
For instance, assuming Broadcom's earnings multiple increases to 29 after three years, in line with the Nasdaq-100, its stock price could hit $210 based on the $7.26 per share earnings estimate seen in the previous chart. That would be a 42% jump from current levels. So, investors looking to buy an AI stock that's capable of delivering healthy growth and is also trading at a reasonable valuation can consider buying Broadcom following its latest drop.
