With its shares up by over 530% in the last five years, Broadcom (NASDAQ: AVGO) has been a solid pick for long-term investors. But past performance doesn't guarantee future returns. And investors will be wondering if the next half decade will be as kind as the previous one.
Let's dig deeper into how this semiconductor company compares to the market leader, Nvidia, in the artificial intelligence (AI) market.
Since the launch of OpenAI's ChatGPT in late 2021, many tech companies have enjoyed a surge in demand for data-center equipment needed to run and train large language models (LLMs). Nvidia has been the top beneficiary of this trend. But other companies like Broadcom have also boomed even though they serve different sides of the industry.
While Nvidia's bread and butter comes from general-purpose AI chips like its flagship B100, designed to maximize speed and processing power, Broadcom focuses on application-specific integrated circuits (ASICs).
These custom chips are tailor-made for a client's specific workload, making them more affordable and efficient. Broadcom makes ASICs for major tech companies like Alphabet and Meta Platforms. And this niche allows it to hold its own in an AI hardware industry otherwise dominated by Nvidia. Broadcom also provides software solutions to help clients build their own private cloud-computing networks.
Broadcom's growth is respectable although not mind-blowing. In the second quarter, revenue jumped 43% year over year to $12.5 billion based on growing demand for its hardware and software-infrastructure solutions. However, this includes sales from VMware, a software company Broadcom acquired for $69 billion in late 2023. Excluding the VMware acquisition, Broadcom's annual-growth rate falls to just 12%.
For comparison, Nvidia's Q2 sales jumped 122% year over year to $30 billion, driven primarily by organic growth in its data-center chip business, which supplies its graphics processing units (GPUs) to AI clients. Gross margins are another significant difference between the two. While Nvidia keeps 75% of its sales before operating expenses, Broadcom keeps just 62%.
To make matters worse, Nvidia also wants a slice of Broadcom's ASICs business. In February, it announced plans to create a new business unit focused on designing custom chips for cloud-computing companies. And if this new segment is successful, it will present even more competition for Broadcom's AI hardware business, possibly sending margins even lower.
When it comes to valuation, Broadcom and Nvidia look similar on the surface -- with forward price-to-earnings (P/E) multiples of 28 and 32, respectively. However, when growth potential is considered, Nvidia is clearly the much-cheaper stock.
Still, there are some reasons why Broadcom might deserve a premium over its faster-growing cousin. For starters, Broadcom is much more diversified. While Nvidia gets almost all of its growth from its high-end AI GPUs, Broadcom has its fingers in many different pies, including software, routers, and internet-connectivity devices. Broadcom is a mass-market chipmaker; its sales come from many sectors of the economy, making it very resistant to a potential downturn in any specific one.
The company's diversification is an asset as more analysts begin to fear that generative AI technology might not live up to the hype. With all this in mind, the stock could have a place in a diversified portfolio, but investors may also want to sit on the sidelines to see if growth eventually picks up.
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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. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Meta Platforms, and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.