The advent of artificial intelligence (AI) in late 2022 sparked a blistering run for a number of companies at the forefront of the technology, adding numerous new members to the trillion-dollar club. Among the most recognizable symbols of this trend are the so-called "Magnificent Seven" stocks.
Each of these companies is an industry leader in their respective field and at the forefront of AI technology. They've also been among the most consistent performers over the past couple of years.
However, investors may be surprised to learn that Broadcom (AVGO 2.10%) has actually outperformed every one of the Magnificent Seven stocks over the past year, as its stock has soared 90%. Furthermore, developments that came to light during the company's recent quarterly report should drive further gains.
Below, I'll look at what's fueling Broadcom's meteoric rise and why this trend is poised to continue.
Image source: Getty Images.
An AI alternative
Advanced processors, particularly the graphics processing units (GPUs) developed by Nvidia (NVDA +0.64%), have provided the computing power that allowed generative AI to flourish. While GPUs are unmatched in providing the computational horsepower that underpins AI, they aren't the only game in town.
Broadcom provides a host of Ethernet switching and networking products that are staples in data centers, where most AI processing occurs. However, it's Broadcom's application-specific integrated circuits (ASICs) that are the biggest opportunity.
These custom-designed AI accelerators, also called XPUs, are customized for specific tasks, which makes them more energy efficient. While they don't have the inherent flexibility of GPUs, many enterprises are willing to accept the trade-off due to the rising energy costs that come with adopting AI.
The robust demand was apparent in the company's recent financial report. In Broadcom's fiscal third quarter (ended Aug. 3), the company delivered record revenue of $15.9 billion, which accelerated 22% year over year, driving adjusted earnings per share (EPS) of $1.69, which jumped 36%. The company left no doubt that AI was fueling its growth, as its AI-based revenue surged 63% year over year to $5.2 billion.
The results easily cleared Wall Street's expectations, as analysts' consensus estimates called for revenue of $15.82 billion and adjusted EPS of $1.66.
Management also provided an update for its business that suggests this could be just the beginning. Broadcom noted that demand from its three biggest hyperscale customers continues to increase. The company hasn't confirmed the identity of these customers, but it's widely believed they are Alphabet, Meta Platforms, and TikTok parent ByteDance.
During the earnings call, CEO Hock Tam confirmed, "We continue to gain share at our three original customers." He also raised expectations for the company's AI-centric business next year, saying growth will exceed the 50% to 60% growth that it forecast for fiscal 2025.
Perhaps more importantly, Broadcom confirmed that it had added a fourth big hyperscale customer, which many on Wall Street believe is OpenAI. Management upgraded the prospect to "qualified customer" and had begun production of "AI racks based on our XPUs."
This development resulted in a $10 billion increase in Broadcom's backlog, bringing the total to $110 billion. Investors are still waiting for an update regarding another previously disclosed prospect, whose business could further boast Broadcom's fortunes.
NASDAQ: AVGO
Key Data Points
What's next for Broadcom?
Melius Research analyst Ben Reitzes argues that the Magnificent Seven should be expanded to the "Magnificent Eight," bringing Broadcom into the fold. He also suggests that Nvidia's share would decline over time, as he believes Broadcom will capture about 30% of the AI chip market. That said, he expects both companies will continue to reap the rewards resulting from the accelerating adoption of AI.
It's worth noting that as Broadcom's stock has nearly doubled over the past year, there's been a commensurate increase in its valuation. The stock has a price-to-earnings ratio (P/E) of 88, which might seem lofty at first glance. However, the more appropriate price/earnings-to-growth ratio (PEG), which takes into account Broadcom's accelerating growth, clocks in at 0.37, when any number less than 1 suggests an undervalued stock. Furthermore, the stock is selling for just 37 times next year's expected sales, which is reasonable, given the magnitude of the opportunity.
Broadcom has a strong track record of growth, an attractive valuation, and is well-positioned to profit from the continuing adoption of AI. That's why it's the $1 trillion stock I would buy if I could buy only one.
