Broadcom’s one-month rally of over 40% has prompted investors to raise concerns over its valuation. By one metric, the company is valued even higher than Nvidia. Concerning the fact that its recent success has come in a very niche market segment, we believe the high valuation is not sustainable and the stock is trading too high.
Broadcom’s recent surge has come on the back of hyperscalers needing to accelerate their AI training models. Companies like Alphabet and Meta Platforms have utilized Broadcom’s expertise in making custom chips to create their own versions of GPUs, ones that excel at repetitive tasks like large language model training.
Analysts expect Broadcom to hit $80 billion in annual revenue by 2027 (currently just above $50 billion). At its current valuation, the stock is trading at a forward price-to-sales ratio of 14. Analysts also expect Nvidia to make $250 billion in revenue by 2027. This makes Nvidia’s price-to-sales hovering just below 14. By this metric, Broadcom is valued higher than Nvidia!
But that’s not all. Investors also need to consider the quality of revenue. Broadcom’s clients that are responsible for its projected growth are a handful of hyperscalers. These hyperscalers not only pay Broadcom to build custom chips but then also have to pay them to develop software. On top of this, they need to train their engineers in collaboration with Broadcom. There is no way any other company other than Big Tech can afford this type of spending. Broadcom has successfully catered to this niche opportunity, but it doesn’t change its fundamental business (which isn’t in very good shape if we exclude the AI impact).
Compare this to Nvidia and you’ll realize why Broadcom isn’t worth the same valuation. Nvidia makes the best GPUs by a long margin. It also sells them better, making it affordable for companies of all sizes. This affordability not only comes from the price but also from software support. Moreover, Nvidia’s gross margins of nearly 80% make its revenue worth a higher multiple in comparison to Broadcom’s gross margins of 63%. If anything, it is Nvidia that is undervalued here, not Broadcom.
Nvidia is 5th on our latest list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 193 hedge fund portfolios held NVDA at the end of the third quarter which was 179 in the previous quarter. While we acknowledge the potential of NVDA as a leading AI investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as NVDA but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published at Insider Monkey.