It has been an eventful year for investors in Broadcom (AVGO -1.47%). The stock has more than doubled in value over the past 12 months. The company split its stock over the summer to lower its share price, but enthusiasm over recent earnings results sent it soaring to nearly $250.
Stock price movements don't always match what's happening with the underlying company. However, Broadcom's recent business developments point to the possibility that it could be the next big winner in the artificial intelligence (AI) chip space -- and perhaps the best stock-split buy heading into next year.
Broadcom's emerging opportunity in AI inference.
The company has long specialized in semiconductors for networking, switching, and other connectivity applications. That expertise has translated to the artificial intelligence (AI) chip segment, where Broadcom is winning business by developing custom chips called XPUs (extreme processing units) that can work together to perform AI-specific tasks.
Thus far, Nvidia has dominated the AI chip market. Its powerful GPUs (graphics processing units) have become the industry standard hardware for providing the specific type of processing power that's best suited for training AI models. Now, as more companies are applying AI to real-world applications, there's an opportunity in AI chips for inference tasks.
You could think of AI training as building a car with enough horsepower to go fast, and AI inference as fine-tuning it to drive smoothly along curvy mountain roads. In AI terms, inference is about translating AI's intelligence to new real-world situations and generating the correct results, and doing it efficiently enough that a smartphone or other small computer can do it.
It's not that Nvidia doesn't have chips suitable for inference applications, but companies may not want to depend on one supplier for all their chips. The AI boom has already significantly expanded Nvidia's profit margins.
Is Broadcom gearing up for a growth spurt?
It's becoming apparent that Broadcom is stepping into this opportunity, specifically in inference chips.
Its fiscal 2024 fourth-quarter report put a spotlight on its strong AI momentum. Total AI revenue for the fiscal year rose 220% to $12.2 billion. Management discussed the outlook for its AI XPUs on the company's earnings call. Though it did not name them specifically, it did acknowledge Broadcom has three high-profile customers with multigeneration product roadmaps and plans to each amass over a million XPU chips on a single cluster by 2027. Two additional large-scale AI customers are also in the earlier stages of developing custom AI XPU chips.
In dollar terms, management estimates that Broadcom's AI-related market opportunity could be between $60 billion and $90 billion in 2027, and it expects that the company will take a leading share of that total. Reports have emerged throughout the year that Broadcom is working with ChatGPT developer OpenAI and Apple on inference chips, which would fit the profile management described.
If so, it's a legitimate sign that Broadcom could factor even more into the AI chip market than expected, which would be a significant catalyst for the company. Again, Broadcom's AI revenue was only $12.2 billion in its recently ended fiscal 2024.
The stock is still catching up to this opportunity.
It's not always wise to chase hot stocks, and Broadcom, which has risen 50% over the past month alone, is undoubtedly on a heater.
But this isn't hype -- the stock's rise was driven by fundamentals. Analysts are adjusting Broadcom's long-term earnings growth estimates as its AI opportunity comes into focus. Even after the stock's tremendous gains, Broadcom's forward P/E ratio of 40 is a reasonable valuation for a business expected to grow earnings at more than 21% annually over the next three to five years.
AVGO EPS LT Growth Estimates data by YCharts.
The stock trades at a PEG ratio of 1.9, which signals Broadcom's expected growth and valuation are beginning to balance out. I'm OK buying high-quality stocks even when their PEG ratios are in the 2.0 to 2.5 range. Still, more could come as the company's two newer AI chip customers move to their production phases. It's also worth remembering that Broadcom's software business has grown due to its blockbuster VMware acquisition last year.
Broadcom's valuation is still reasonable, making it a compelling stock to buy heading into 2025 and hold at least through the coming AI ramp-up over the next several years.
