There is no doubt that Nvidia has been the driving force behind the artificial intelligence (AI) revolution in the past three years with the help of its graphics processing units (GPUs). These chips have been deployed in huge numbers to power data centers that train AI models, and they are now being used for AI inference as well.
The success of Nvidia's GPUs has led to remarkable growth in its revenue and earnings in recent years. It remains the leader in the AI chip market with an estimated share of 80%, according to brokerage firm Susquehanna.
However, there is a chance that the company's AI chip dominance could start waning, and one competitor has the potential to replace it as the new face of AI.
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Shift toward AI inference helps Broadcom make a bigger dent in AI chips
Broadcom (AVGO +2.86%) is known for designing custom chips, called application-specific integrated circuits (ASICs), along with networking switches and components. It currently lags significantly behind Nvidia in the AI chip market. Its AI revenue of $5.2 billion in its most recent fiscal quarter was well below the $41 billion revenue generated by Nvidia in the previous quarter.
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But Broadcom's AI revenue increased by 63% year over year, outpacing the 56% growth in Nvidia's data center revenue. The latter's growth is quite impressive considering its huge size, but there is a good chance that Broadcom will be able to significantly accelerate its healthy growth due to a shift in AI workload needs.
Earlier this year, Advanced Micro Devices CEO Lisa Su said that the demand for AI inference applications is outpacing the demand for AI model training. Su said that the number of purpose-built AI models for handling specific kinds of workloads in areas such as automaking, healthcare, and finance is also booming. So the need for custom AI processors designed by Broadcom is set to increase.
The company's custom processors are designed to tackle specific workloads as compared to the general-purpose function of Nvidia's GPUs. Custom AI processors not only consume less power, but they are also considered to be more powerful while performing a specific task, when compared to GPUs.
This explains why customers have been lining up to buy custom AI processors and networking chips from Broadcom. OpenAI, which relied on Nvidia to train ChatGPT three years ago, has been the latest company to partner with Broadcom.
The company will design and deploy 10 gigawatts of custom AI processors for OpenAI from 2026 to 2029. Though there has been no disclosure about the financial aspects of this deal, it is estimated that $35 billion worth of AI accelerators are typically deployed in a 1 gigawatt data center. One analyst estimates that this deal could add a total of $100 billion to Broadcom's top line during the contract period.
As such, Broadcom could see a significant expansion in its addressable market following the OpenAI deal. The chip designer reported a strong revenue backlog of $110 billion at the end of its previous fiscal quarter, a number that's well above the $60 billion in revenue that it has generated in the past year. That backlog is likely to have grown much bigger in the wake of the OpenAI deal, as well as the $10 billion contract that it landed from an unnamed client last month.
In all, Broadcom's growing backlog, the fact that it counts the likes of OpenAI, Alphabet's Google, Meta Platforms, and ByteDance as customers -- along with other customers in the company's pipeline -- clearly suggest that its status in the AI chip industry is rising. Moreover, 80% of the chips performing AI inference tasks in 2030 are expected to be ASICs, up from just 15% last year.
Broadcom is the leading player in custom AI processors, with an estimated share of 70%, so it is one of the best ways to capitalize on the huge potential of this market. Management expects to ride the custom AI processor market's growth and corner a 24% share of the overall AI chip market by 2027. That would be more than double its estimated share of 11% in 2025, suggesting that it is likely to eat into Nvidia's dominance.
Broadcom stock is expensive right now, for a reason
Broadcom stock has shot up 94% in the past year, and it is trading at an expensive 87 times earnings right now. However, the forward earnings multiple of 37 suggests that its bottom line is set to expand nicely. Consensus estimates project a 38% increase in Broadcom's earnings this year, followed by an almost identical jump in the next one.
It can sustain such impressive growth beyond the next couple of years considering the points discussed above. And its stock is undervalued taking its growth potential into account. It has a price/earnings-to-growth ratio (PEG) of just 0.55 based on its projected annual earnings increase for the next five years, according to Yahoo! Finance.
A PEG ratio is a forward-looking valuation metric calculated by dividing a company's price-to-earnings ratio by its estimated five-year annual growth rate, and a reading of less than 1 suggests that a stock is undervalued based on the potential growth. So, investors can still consider buying Broadcom since its growing stature in the AI chip market could pave the way for more upside in the long run.
