Better AI Chip Stock: Nvidia vs. Broadcom

When it comes to designing semiconductor chips used to power artificial intelligence (AI) workloads, two companies stand head and shoulders above the rest: Nvidia (NASDAQ: NVDA) and Broadcom (NASDAQ: AVGO). Nvidia has been the biggest early winner in AI chips, but Broadcom has been gaining momentum.

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Two different approaches

Nvidia and Broadcom are taking two very different approaches to the AI chip market. Nvidia is the clear market leader in graphics processing units (GPUs), where it holds a more than 80% market share. GPUs were originally designed to speed up graphics rendering in video games, but due to their fast processing power, they have become the main chips used to power AI workloads.

The secret sauce behind Nvidia's huge market share is its CUDA software platform. It was the first software platform to allow developers to program GPUs for tasks beyond their original purpose, making it the standard on which developers learned to program GPUs. Since then, the company has built a collection of libraries and tools on top of CUDA, called CUDA X, that help enhance the efficiency and scalability of training AI models and improve inference times.

Broadcom, on the other hand, helps its customers develop custom AI chips called application-specific integrated circuits (ASICs). ASICs are designed for very specific tasks. As such, these chips have better performance and consume less power than mass-market GPUs. The downside is that it takes considerable time to develop these custom chips and there are a lot of upfront costs, as well. They also don't provide that same type of flexibility as GPUs, which can be programmed for a variety of tasks.

Not surprisingly, in the initial surge of the AI infrastructure buildout, Nvidia's GPUs were the most common chips that hyperscalers (operators of large data centers) used to train AI models and build out data center infrastructure to meet strong demand. After all, mass-market GPUs were much more readily available and Nvidia's CUDA software platform made them easily programmable for the tasks at hand.

However, as Nvidia's GPU prices have skyrocketed due to its dominant market position, more and more companies have started to design their own AI custom chips with the help of Broadcom. Alphabet was the company's first custom AI chip customer, with Broadcom helping it develop its Tensor Processing Unit (TPU) for its Google Cloud business. These chips are designed specifically to optimize AI workloads within Google Cloud's TensorFlow framework. Alphabet has credited them for improving performance, as well as reducing its operating costs due to their lower power consumption.

Broadcom has progressively acquired more custom AI chip customers. Meta Platforms and OpenAI are reportedly the next companies to collaborate with Broadcom in developing AI chips. Broadcom has forecast that these three customers will have a serviceable market opportunity valued between $60 billion and $90 billion for its fiscal year 2027 (ending in October 2027). Currently, Broadcom's annual AI revenue run rate stands at just over $16 billion, indicating a significant growth potential.

Meanwhile, the company has added additional custom AI chip customers beyond its initial three. Apple and TikTok owner ByteDance are widely believed to be its next two customers that are furthest along in their development. It took about 15 months for Alphabet to go from design to production for its chips, which gives a general time frame of how long it could take before these customers can become meaningful revenue contributors. Broadcom has also hinted at two additional custom AI chip customers.

Image source: Getty Images.

Which is the better stock to buy?

From a valuation perspective, the companies trade at similar forward price-to-earnings (P/E) multiples of 21.5 times for Nvidia and 23 times for Broadcom. While Nvidia still has a strong opportunity in front of it, Broadcom appears to have the stronger growth prospects going forward.

Part of this is due to the law of large numbers, as Nvidia has already grown its revenue by more than 380% over the past two years. Meanwhile, Broadcom has been making strong inroads into the AI chip space. Given the time and upfront costs involved with designing custom chips, Broadcom's customers will be using these chips for large projects.

I think both companies should continue to win their fair share of the AI chip market and both will see solid growth. However, I prefer Broadcom's stock a bit more at current levels given the huge opportunity in front of it. Of course in the real world, you should be able to own both over the long run.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Geoffrey Seiler has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet, Apple, Meta Platforms, and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.