Broadcom (AVGO 2.60%) had an incredible 2024, with the stock more than doubling. After a run-up like that, many investors might wonder how much upside potential is left — if any.
Broadcom is in a great position in the artificial intelligence (AI) industry. It helps design custom AI accelerators, and also sells connectivity switches used in AI data centers. But after the emergence of DeepSeek’s R1 as a less computationally demanding model, is Broadcom still a solid stock pick right now?
Broadcom’s investment thesis centers around increased use of its AI hardware
Broadcom isn’t just a business devoted to serving the AI market. Its products include mainframe software, virtual desktops (mainframe-based software that allows users to access their personal desktop environments and software from any device), and an AI product line. However, most of the excitement around the stock lately has been driven by its virtual desktop and AI products.
In late 2023, it completed the acquisition of VMware, which provides virtual desktop software. This has added lots of growth to the company, but Broadcom’s management has angered VMware’s established customers with some of its actions.
Broadcom hit VMware clients with jaw-dropping price hikes (AT&T, for example, said its VMware bills rose by 1,050%), prompting a lawsuit. Many customers have begun to look elsewhere for virtual desktop software.
On the AI side, Broadcom was generating massive amounts of revenue growth from sales of hardware for the giant AI data centers now being built. Sales of custom AI accelerators and networking components grew by 220% to $12.2 billion in Broadcom’s fiscal 2024, which ended Nov. 3. That represented around 24% of its total revenue.
However, the stock plunged by more than 17% on Monday after the announcement of DeepSeek’s R1 AI model, which was supposedly trained for just $5.6 million. However, the market’s reaction may have been a bit rash.
There’s a lot of skepticism over that $5.6 million figure because DeepSeek didn’t dive into details about how it was derived. However, R1 has clear efficiencies over many of the domestically developed generative AI models, so this issue shouldn’t be ignored.
Regardless, the market’s current attitude is: “Big tech won’t need to keep spending all of this money to build out AI infrastructure if tech companies can train and run AI software more efficiently.” As a result, any company whose business is tied to providing hardware for these servers saw its stock sell off this week.
Still, AI hardware investments aren’t likely to stop just because one competitor has debuted a more advanced model.
With that in mind, is Broadcom stock a buy?
The stock still isn’t cheap even after the sell-off
Prior to the sell-off, I would not have been a buyer of Broadcom stock; it was just too expensive. After its recent haircut, it trades for a more reasonable 32 times forward earnings.
AVGO PE ratio (forward) data by YCharts; PE = price to earnings.
However, there are still questions about how the VMware business will fare if Broadcom continues to impose such egregious price hikes on clients. The recent consensus among Wall Street analysts was that the company would deliver 19% revenue growth in its fiscal 2025. That could prove to be an overly optimistic estimate if AI investments collapse due to DeepSeek.
Broadcom’s valuation is still expensive compared to its big tech peers, and with so many questions surrounding the outlooks for AI and VMware, I think investors would be well advised to avoid the stock for now.
