Broadcom Stock Is a Winner With Big Upside Potential

Luke Lango

Updated Tue, Sep 18, 2018, 12:28 AM

Thanks to the mainstream emergence of multiple secular-growth technology trends, the global semiconductor market has been on fire recently. While financial media outlets love to talk about semi-darlings Nvidia (NASDAQ:NVDA), Advanced Micro Devices (NASDAQ:AMD), Micron (NASDAQ:MU), and other high-flyers, one semi-stock which is often left out of the discussion is Broadcom (NASDAQ:AVGO).

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And, that seems to be just fine with AVGO shareholders. Not only have Broadcom’s numbers boomed with the rest of the semiconductor industry over the past five years, but, during that stretch, AVGO stock has rallied more than 500%.

This rally is far from over.

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Global semiconductor tailwinds promise to persist for the foreseeable future thanks to greater enterprise and consumer technology adoption. Consequently, Broadcom’s revenue growth promises to remain healthy. Acquisitions will keep happening, and those will add more firepower to top-line growth. Margins will keep powering higher thanks to higher-value products. Profit growth will remain robust. And, most importantly, AVGO stock will head higher.

Because of a presently cheap valuation (11.5 times forward earnings), I think AVGO stock has tremendous upside potential over the next several months and years. My numbers suggest this stock could finish the year around $260 (10%-plus upside), and head towards $350 in 4-5 years (nearly 50% upside). Thus, I’m confident in labeling AVGO stock both a near- and long-term winner.

Broadcom’s Fundamentals Are Solid

The fundamentals underlying Broadcom have been very good.

The global semiconductor market has rallied in a huge way over the past several years. Broadcom, as one of the largest players in this market, has naturally ridden these tailwinds to huge operational gains. Specifically, the company has been a huge winner thanks to increased smartphone adoption, robust IT spend, healthy datacenter growth and the mainstream emergence of IoT (Internet-of-Things). Also, Broadcom has a reputation for snapping up competitors and supercharging growth via accretive acquisitions.

Put it all together and those strong fundamentals are why AVGO stock has risen by more than 500% over the past five years.

To be sure, success of that magnitude isn’t repeatable. Global semiconductor tailwinds are cooling. Namely, the smartphone market is starting to become saturated. But, when it comes to the data-center and IoT growth narratives, those narratives are still in their early innings. Thus, while growth in the global semiconductor market may be slower going forward, it will still be healthy.

Naturally, that will provide a lift for AVGO stock. Not a 500% lift. But a solid lift that will help power shares higher both in the near and long term.

The Stock Has Healthy Upside

The growth narrative at Broadcom is good, but the most attractive thing about AVGO stock is the valuation.

AVGO stock trades at just 11.5X forward earnings. That seems anemic on all fronts. Close peer Qualcomm (NASDAQ:QCOM) trades at 20X forward earnings. The whole semiconductor space trades on average around 13X forward earnings. And Broadcom, Qaulcomm and the whole semiconductor space have similar long-term earnings growth prospects of ~15% per year.

Also, AVGO stock normally trades around 14X forward earnings. Today’s 11.5 forward multiple, then, is not just a deep discount to peers, but also a deep discount to intrinsic growth potential and historical standards.

Why is that? The market is concerned about AVGO’s recent acquisition of CA (NASDAQ:CA). Analysts downgraded the stock and investors sold as the market wasn’t convinced of the synergies the deal offers or the premium Broadcom paid. But, since AVGO stock dropped following the announcement of that deal, the company has reported continued strong operating results and the stock is bouncing back.

This bounce-back should persist. The global semiconductor market is expected to grow at a modest 3% annualized pace over the next five years. Broadcom should easily grow revenues in line with the market. During that stretch, gross margins should rise due to a shift towards higher value products, while expense rates should drop due to healthy revenue growth. Overall, I think this company can do about $25 in earnings per share in five years.

A historically-average 14 forward multiple on that implies a four-year forward price target of $350. Discounted back by 10% per year, that equates to a year-end price target of over $260. So, upside looks compelling in both a near- and long-term window.

Bottom Line on AVGO Stock

AVGO stock has been a big winner over the past five years, and will continue to be a winner over the next five years thanks to continued strength in the global semiconductor market.

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At the moment, AVGO stock seems significantly undervalued due to concerns regarding the CA acquisition. These concerns will inevitably pass, and once they do, this stock could rally 10% or more in a hurry.

As of this writing, Luke Lango was long NVDA, AMD, and AVGO.