No chipmaker has benefited more from the rapid rise in artificial intelligence (AI) spending than Nvidia (NVDA -2.09%). The company's graphics processing units (GPUs) are essential for any company looking to develop and train large language models and build generative AI applications.
Nvidia flew past the $1 trillion milestone in May 2023. It's more than tripled since that point, becoming one of just three companies with a market capitalization above $3 trillion. But Nvidia isn't the only company that's seen its market capitalization soar as AI spending booms. In fact, AI advancements are virtually inseparable from the success of nearly every company valued at over a trillion dollars. The newest member, which both complements and competes with Nvidia, is no different.
The newest artificial intelligence chip stock in the $1 trillion club is Broadcom (AVGO -1.47%). The stock passed the milestone after a stellar fourth-quarter earnings report on Dec. 12. Here's how the company became a leading AI chipmaker worth 13 figures.
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The company making the next generation of AI chips
Broadcom is a well-diversified business. It has an enterprise software segment, led by VMWare and Symantec. It also makes semiconductors for applications, including wireless phones, WiFi, and Bluetooth. But what's really driving the business are two specialized semiconductor applications: Its networking chips, and its AI accelerators.
Broadcom's networking chips are essential infrastructure for AI data centers. While hyperscalers are paying billions for Nvidia's GPUs, they need Broadcom's chips to get the most out of their processing power. Broadcom's Tomahawk and Jericho switches ensure that data moves quickly and efficiently from one server to another. That means there's less redundancy and downtime in processing. And when you're trying to make the most out of billions of dollars' worth of chips, every second counts.
There's no company that's even close to Broadcom's technology when it comes to developing these chips. Moreover, there's nobody in charge of a hyperscale data center who's going to risk their job by switching to a competitor's offering, no matter how much money it could save the business. So, as data centers grow the number of expensive GPUs and other chips in their server racks, Broadcom's business has grown exponentially.
Even more promising is its custom AI accelerator business. These are the next generation of AI chips.
Broadcom works with several companies to develop purpose-built AI chips for their data centers. Its three biggest customers are Alphabet, Meta Platforms, and TikTok parent ByteDance. Management estimates that these three companies will present an addressable market of between $60 billion and $90 billion by 2027. Considering all three companies' potential gains from advancements in AI, the high end of that number seems more likely than the low end.
Management also announced that it signed deals with two new customers building their own next-generation chips. Broadcom won't disclose the details, but many believe those customers to be Apple and OpenAI.
Apple is familiar with Broadcom's work. It used Google's TPUs to train Apple Intelligence. Apple's big push to incorporate AI into its devices at a system level could lead it to become Broadcom's biggest customer in short order. That leaves tremendous upside in management's addressable market outlook, which doesn't include the new customers.
Indeed, with its networking chips and AI accelerators, Broadcom looks well-positioned to benefit from the maturing development of artificial intelligence. Going forward, management plans to split its semiconductor reporting into AI and non-AI segments. The growth of the former will drive results for the entire business for the foreseeable future.
It's not too late to buy
Despite shares soaring more than 24% after the company reported its fourth-quarter earnings, the outlook for the business remains strong enough to justify its current price.
Management's $60 billion to $90 billion addressable market outlook represents a compound annual growth rate for the AI semiconductor segment of greater than 60%. And with the upside of two potential new customers, the growth could be significantly higher by 2027.
While AI semiconductors remain a small part of Broadcom's business today, they're the driving force behind its future. Even after tripling AI sales in 2024, management still expects AI chips to account for roughly one-quarter of the company's total revenue in the first quarter of 2025. But as AI chips become a bigger part of Broadcom's business and continue to grow at a rapid pace, the company's earnings growth should remain strong for a very long time. Analysts currently expect 28% earnings growth next year and 20% growth in 2026.
As a result, investors should be willing to pay a premium valuation today for a stock that's already growing earnings at a strong pace. Shares trade for about 36 times forward earnings as of this writing. That's definitely a premium price, and investors should consider the risks of investing at this price. Specifically, AI spending may not continue at the rampant pace it's seen in the last two years. But the stock traded at a similar valuation earlier in 2024, and management just showed why it was worth the price then. Investors looking for an alternative to Nvidia may want to consider Broadcom for their portfolios.
