Most investors who follow the semiconductor industry are probably familiar with graphics specialist NVIDIA (NASDAQ:NVDA) and chip generalist Broadcom Limited (NASDAQ:AVGO), the latter of which was formed from the recent merger of Broadcom Corporation and Avago Technologies.
Although both are excellent companies, it's a worthwhile exercise to look at how these two compare in a number of key factors that can be quite important to investors.
Diversification versus specialization
Broadcom Limited is a very diverse company, expected to bring in around $13 billion revenue in the current fiscal year from a broad set of market segments. In a recent investor presentation, Broadcom broke its end markets down into four major buckets:
- Wired infrastructure
- Wireless communications
- Enterprise storage
- Industrial and other
In its most recent quarter, 38% of sales came from enterprise storage, 33% from wireless communications, 22% from wired infrastructure, and 7% from industrial and other. To serve these markets, Broadcom develops quite a wide range of products based on a fairly broad set of what the company describes as "core technologies."
In contrast, NVIDIA is a very specialized company, focused primarily on building graphics hardware and associated software aimed at gaming applications with adjacent opportunities in professional visualization and high-performance computing. In its last fiscal year, NVIDIA brought in roughly $5 billion in revenue, about $4.2 billion of which came from the sale of graphics processing units. Tegra processors aimed principally at automotive applications and royalty payments from Intel (NASDAQ:INTC) make up the remainder.
For a long time, NVIDIA had resisted putting in a meaningful capital return program, but over the last couple of years, it has really stepped things up on that front. Management says that it plans to return about $1 billion to shareholders in the current fiscal year through both stock buybacks as well as dividends. This return represents about 1/18th of the company's current market capitalization and about 100% of the company's trailing-12-month free cash flow.
Broadcom, on the other hand, has different priorities vis-a-vis capital allocation. The combined entity has a significant amount of debt, particularly as Avago had to raise quite a lot of debt in order to fund the purchase of Broadcom.
Unsurprisingly, according to Broadcom Limited CEO Hock Tan, the first priority around cash is to "pay down debt." The second priority is to boost dividends. It doesn't look like the company will be doing much in the way of large share repurchases for the foreseeable future.
Current analyst estimates call for NVIDIA to bring in about $5.32 billion this year, representing growth of about 6.2%. In the following year, growth is expected to slow to just 2.2%.
In contrast, Broadcom Limited is expected to see revenue surge 22.9% in the coming fiscal year. That being said, it's worth noting that in the first quarter of the current fiscal year, financial results include just the results from what was previously known as Avago. This means that the year-over-year comparison is a bit "inflated" as a result of the next fiscal year having a full year of revenue from both of the combined companies.
Longer term, I suspect that Broadcom's growth prospects are more reliable as it is exposed to more end markets, a number of which (in particular, wireless) are growing at a faster clip than what I believe gaming-oriented graphics chips will.
That said, in terms of valuation on an enterprise value to free cash flow basis (over the trailing-12-month period), NVIDIA is substantially cheaper than Broadcom limited (13.36 times EV/free cash flow versus 25.09 times EV/free cash flow). This seems to suggest that more robust growth prospects for Broadcom Limited are already baked in to the stock price.
Better buy? It depends
For investors who strongly believe that demand for PC gaming-oriented hardware will continue to surge and that self-driving cars requiring insane amounts of computing power are the "next big thing," NVIDIA is certainly the more interesting of the two stocks.
For perhaps more conservative investors who want to bet on a chip company with exposure to a lot of different end markets but don't want to buy something as diverse as a semiconductor ETF, Broadcom Limited could be the better choice.