No chipmaker has benefited as much from the rapid rise artificial intelligence (AI) that Nvidia (NASDAQ:NVDA). The company’s graphics processing units (GPUs) are essential for any business looking to develop and train large language models and create generative AI applications.
Nvidia passed the $1 trillion mark in May 2023. That figure has more than tripled since then, becoming one of three companies with a market capitalization exceeding $3 trillion. But Nvidia isn’t the only company seeing its market capitalization soar as AI spending explodes. In fact, advances in AI are virtually inseparable from the success of almost every trillion-dollar-plus company. The newest member, which complements and competes with Nvidia, is no different.
The newest artificial intelligence chip stock in the $1 trillion club is Broadcom (NASDAQ: AVGO). The stock hit the milestone after a strong fourth-quarter earnings report on Dec. 12. Here’s how the company became a leading maker of 13-figure AI chips.
Image source: Getty Images.
Broadcom is a well-diversified company. It has an enterprise software segment, led by VMWare and Symantec. It also makes semiconductors for applications such as wireless phones, WiFi and Bluetooth. But what really drives the company are two specialized semiconductor applications: its network chips and its AI accelerators.
Broadcom’s networking chips provide critical infrastructure for AI data centers. While hyperscalers pay 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. This means there is less redundancy and downtime in processing. And when you’re trying to get the most out of billions of dollars worth of tokens, every second counts.
No company comes close to Broadcom’s technology in developing these chips. Additionally, no hyperscale data center manager is going to risk their job by switching to a competitor’s offering, no matter how much money it might save the company. So as data centers increase the number of GPUs and other expensive chips in their server racks, Broadcom’s business has grown exponentially.
Its custom AI accelerator business is even more promising. This is the next generation of AI chips.
Broadcom is working with several companies to develop AI chips specifically for their data centers. Its three biggest clients are Alphabet, Metaplatformsand TikTok parent ByteDance. Management estimates that these three companies will present an exploitable market of between $60 billion and $90 billion by 2027. Given the potential gains of all three companies from advances in AI, the high end of this figure seems more likely than the low end. down.
Management also announced that it has signed agreements with two new customers building their own next-generation chips. Broadcom won’t release details, but many believe these customers are Apple and OpenAI.
Apple knows Broadcom’s work. It used Google’s TPUs to train Apple Intelligence. Apple’s extensive efforts to integrate AI into its devices at a system level could lead it to become Broadcom’s largest customer in the near term. This leaves huge room for improvement in management’s addressable market outlook, which does not include new customers.
Indeed, with its network chips and AI accelerators, Broadcom seems well placed to benefit from the growing 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 company for the foreseeable future.
Despite shares rising more than 24% after the company reported its fourth-quarter results, the company’s prospects remain strong enough to justify its current price.
Management’s potential market outlook of $60 billion to $90 billion represents a compound annual growth rate of more than 60% for the AI semiconductor segment. And with the benefit of two new potential customers, growth could be significantly higher by 2027.
Although AI semiconductors represent only a small part of Broadcom’s business today, they are the engine of its future. Even after tripling AI sales in 2024, management still expects AI chips to account for about a quarter of the company’s total revenue in the first quarter of 2025. But as AI chips become a larger part of Broadcom’s business and continue to grow at a rapid pace, the company’s earnings growth is expected to remain strong for a very long time. Analysts currently expect earnings growth of 28% next year and 20% in 2026.
As a result, investors should be willing to pay a premium valuation today for a stock whose earnings are already growing at a rapid pace. Shares trade at around 36 times forward earnings as of this writing. This is certainly a high price, and investors should consider the risks of investing at this price. Specifically, AI spending may not continue at the breakneck pace seen over the past two years. But the stock traded at a similar valuation earlier in 2024, and management then simply showed why it was worth that price. Investors looking for an alternative to Nvidia may want to consider Broadcom for their portfolios.
Before buying Broadcom stock, consider this:
THE Motley Fool Stock Advisor The analyst team has just identified what they think is the 10 best stocks for investors to buy now…and Broadcom wasn’t one of them. The 10 selected stocks could produce monster returns in the years to come.
Consider when Nvidia made this list on April 15, 2005…if you had invested $1,000 at the time of our recommendation, you would have $822,755!*
Equity Advisor provides investors with an easy-to-follow plan for success, including portfolio building advice, regular analyst updates, and two new stock picks each month. THE Equity Advisor The service has more than quadrupled the return of the S&P 500 since 2002*.
Suzanne Frey, an executive at Alphabet, is a member of the board of directors of The Motley Fool. Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Adam Levy holds positions at Alphabet, Apple and Meta Platforms. The Motley Fool holds positions and recommends Alphabet, Apple, Meta Platforms and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
6 mins read
