Chip stocks have been a driving force in the market over the past few years, largely due to the artificial intelligence (AI) infrastructure buildout. That spending is only set to ramp up next year, as cloud computing companies, AI start-ups, and other tech companies race to build out the computing power needed to run AI workloads.
While there should be multiple winners from this ongoing spending, I think the top-performing chip stock next year will be Broadcom (AVGO +0.11%).
A networking and ASICs winner
Broadcom is a leader in data center networking, where it makes components such as Ethernet switches, optical receivers, digital signal processors (DSPs), and network interface cards (NICs). These components are critical in managing data flow and distributing AI workloads across servers, and as AI chip clusters increase in size and complexity, their importance grows. Not surprisingly, given the data center buildout, this part of Broadcom's business has seen strong growth.
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The company also operates an infrastructure software business that it has cobbled together through various acquisitions over the years. However, its largest business in this segment is VMware, which it bought in November 2023. VMware is a virtualization and cloud computing solutions provider whose virtualization products allow several virtual machines to be run on a single server.
After acquiring VMware, Broadcom has moved its customers to a subscription model and looked to upsell customers to its VMware Cloud Foundation (VCF) platform, which lets customers manage AI workloads across public clouds and their own on-premises data centers. The business has been a solid grower as large organizations look to take a hybrid AI infrastructure approach and avoid vendor lock-in.
However, Broadcom's biggest opportunity moving forward is with its ASICs business. ASICs, or application-specific integrated circuits, are custom chips preprogrammed to perform particular tasks. Because they are hardwired before they are made, ASICs tend to perform the tasks for which they were designed more efficiently than general-purpose chips, like graphics processing units (GPUs). Given how power-hungry running AI workloads is, more companies have started to turn to Broadcom to help them make custom AI chips and reduce costs.
Broadcom helped Alphabet (GOOGL 0.63%) (GOOG 0.81%) design its very well-regarded tensor processing units (TPUs), which led to other companies flocking to its ASICs solutions. Earlier this year, it said its three customers that are the furthest along -- believed to be Alphabet, Meta Platforms, and TikTok owner ByteDance -- were a $60 billion to $90 billion opportunity in its fiscal 2027.
Meanwhile, a fourth customer, possibly Apple, has placed a $10 billion order for next year. That's a huge opportunity, as Broadcom is only set to generate just over $63 billion in revenue this fiscal year (ended Nov. 2).
That's not all, though. After working with OpenAI on custom AI chips over the past 18 months, Broadcom inked a deal with the large language model (LLM) maker to supply it with 10 gigawatts of custom AI chips. Based on current Nvidia GPU pricing, that would value the deal at a whopping $350 billion.
Broadcom will begin supplying OpenAI with the custom chips in the second half of next year and complete the order by the end of 2029. That would equate to close to $100 billion worth of chips a year.
NASDAQ: AVGO
Key Data Points
Why Broadcom will be the top-performing chip stock
From a valuation perspective, Broadcom remains attractively priced based on the opportunities in front of it. It trades at a forward price-to-earnings (P/E) ratio of just about 30 times and a price/earnings-to-growth ratio (PEG) of under 0.4, with positive PEGs below 1 considered undervalued.
Broadcom is set to see very strong growth next year, but its potential fiscal 2027 growth is just explosive. The market tends to be forward-looking, and as we get closer to its fiscal 2027 and all this potential revenue, I'd expect the stock to rally hard and be the best-performing chip stock next year.
