AI wave takes this stock to record as investors look beyond Magnificent 7

Stocks outside the Magnificent 7 are seeing renewed investor interest as the AI demand wave continues to power markets higher.

Jan 23, 2024 - 08:30

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AI wave takes this stock to record as investors look beyond Magnificent 7

Broadcom (AVGO) - Get Free Report shares moved higher Monday, taking the network chipmaker to an all-time high as investors continue to snap up tech stocks tied to the artificial-intelligence boom.

Goldman Sachs noted in a report published Monday that hedge funds are buying AI-related stocks at the fastest pace in five months, while Bank of America's closely tracked Fund Managers' Survey indicates longer-term investors are the most bullish on U.S. stocks since December 2021.

Much of that optimism, for both profits and overall market performance, is linked to the advance of the so-called Magnificent 7 tech stocks (Microsoft, Apple, Google, Amazon, Meta Platforms, Tesla and Nvidia) were responsible for around two-thirds of the S&P 500's overall gains last year.

And despite big slumps for Apple (AAPL) - Get Free Report and Tesla (TSLA) - Get Free Report, the Mag 7 stocks have gained around 3.6% so far this month, well ahead of the 2.3% gain for the S&P 500 and just ahead of the Nasdaq's 3.4% advance.

Broadcom, in fact, has surged more than 35% since its disappointing fiscal-fourth-quarter earnings report in early December. That's more than four times faster than the broader Nasdaq and nearly double the pace of the benchmark VanEck Semiconductor ETF, as investors continue to search for value in the surging AI marketplace.

Broadcom: AI-related sales growing

The group forecast fiscal 2024 revenues in the region of $50 billion, which fell just shy of Street forecasts, but said AI-related sales would comprise around a quarter of that total, up from 15% in the prior year, with a profit margin based on earnings before interest, taxes, depreciation and amortization of around 60%.

"What we're seeing is a market that continues to grow to accelerate," Chief Executive Hock Tan told investors on a conference call on Dec. 7. "As architectures of large language models, software models continues to change, I mean literally change on the fly, we are also seeing the requirements for compute silicon change."

"I fully concur with AMD when they indicate that it looks like demand appears to be accelerating rather than staying stable or decelerating," Tan added, referencing an estimate from Advanced Micro Devices (AMD) - Get Free Report that the market for AI accelerators could be as large as $400 billion.

Broadcom well-positioned in chips, networks

Broadcom's position in both the chip and networking space also provides some hedging against the risk of losing a big customer, while its plans to convert clients of VMWare, which it purchased last year, into recurring-revenue contracts also adds a measure of top-line consistency.

Standard & Poor's, in fact, lifted its credit rating on Broadcom to BBB late last year, and assigned it a positive outlook, on the better cash-flow prospects the $69 billion takeover creates.

"Unlike previous acquisitions, VMware is a growth-oriented endeavor, which will allow the company to penetrate public and private cloud markets," said Nancy Tengler, CEO of Laffer Tengler Investments, in Scottsdale, Arizona. "Penetrating both sides of the aisle is important, as we are seeing many companies take a hybrid approach to the cloud."

The group has only a small number of major clients, however, and its reliance on Apple (AAPL) - Get Free Report for around 13% of its overall sales, as well as nearly a quarter of its semiconductor revenue, remains a concern.

As does its relationship with Google, which is looking to claw back some of the AI momentum it lost to Microsoft (MSFT) - Get Free Report last year and will ramp the production of its Tensor processing units used to accelerate machine-learning workloads in its cloud offering.

Those TPUs, as they are known in the tech sector, are powered by chips made by Broadcom in a deal that contributed around $3 billion in 2023 revenue.

Reports that Google was looking to replace Broadcom with chips made by Marvell Technology (MRVL) - Get Free Report were swiftly countered by the tech giant, which described Broadcom as an "excellent partner" that is key to its long-term cloud growth.

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"Comments on generative AI will be in focus this quarter, as AI-related semi-revenue is expected to grow ~50% quarter-over-quarter and 200% year-over-year (from last quarter’s call)," Tengler added. "The majority of this growth is expected to be driven by hyperscalers building out AI training clusters."

AI remains the key revenue driver

Broadcom is scheduled to report fiscal-first-quarter earnings after the close of trading on March 7.

KeyBanc Capital Markets analyst John Vinh, who carries an overweight rating on Broadcom stock, says he expected "continued growth in hyperscale primarily related to AI" for semiconductor revenue, alongside "strong demand for AI networking."

"We expect strong AI momentum to continue through FY24, with the mix reaching 25% of semi vs. 15% in FY23, supported by both compute offload (Google TPU) and networking," he said in a recent client note. "We expect the semi business (excluding AI) to stabilize with a gradual recovery expected over the next several quarters"

The shares hit a intraday record of $1,231.33 each in Monday's regular trading session.

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