Like many chipmakers, Broadcom has taken a big hit this year -- its stock is down 20% through Aug. 29.
The concern among investors is that the weakening economy will slow purchases of new technology products by both consumers and businesses. It's a legitimate worry. Sales growth for communications hardware -- a product category loaded with Broadcom silicon -- has declined from 30% year-over-year at the end of 2010 to under 10% today, according to a recent report from technology investment-banking boutique Kaufman Bros. That would be alarming if Broadcom were still priced like a growth stock. Four years ago Broadcom had a P/E of 130. Today, however, it trades at just 11.6 times earnings, slightly cheaper than the S&P 500.
Granted, that 130 P/E was before the Great Recession and before Broadcom founders Henry Samueli and Henry T. Nicholas III stepped down in the wake of 2008's stock-options backdating scandal. (Criminal charges against both were eventually dismissed.) Nevertheless, we think Broadcom's dirt-cheap valuation more than adequately protects investors from economic risks. Just as important, the company is extremely well positioned for future growth. Oppenheimer analyst Rick Schafer calls Broadcom "one of the best growth stories in large-cap [semiconductors]." His price target: $55, which would be a 57% increase from Broadcom's current $35 share price.
Broadcom's chips are built into many of today's hottest tech products -- from iPhones and iPads to HD cable set-top boxes. The company has an 80% market share, for example, in the so-called combo chips that provide Wi-Fi and Bluetooth for smartphones. Broadcom chips enable Internet connectivity for the iPad and other tablet computing devices. (Apple accounted for about 11% of Broadcom's revenue last year, according to Pacific Crest Securities.)
On the enterprise side, Broadcom stands to gain from the ongoing shift by Internet service providers from TDM- to IP-based networks. The latter move high-definition video and other rich content more efficiently -- a big deal given the strain that services like Netflix streaming put on networks -- and Broadcom Ethernet chips are key hardware components in many IP-based networks. "I do think Broadcom's valuation is pretty compelling here," says mutual fund manager Ryan Jacob, who has 3% of the money in his Jacob Internet Fund in Broadcom. "One of the things Broadcom has going for it in this economy -- besides being involved in all the fastest-growing areas -- is a history of adding functionality to its chips while simultaneously lowering costs." Another reason this is an opportune time to buy.