Why I Sold Broadcom Stock: Mismatch Between Expectations And Reality (NASDAQ:AVGO)

Broadcom (NASDAQ:AVGO) has been a surprisingly sturdy performer over the previous half yr. The corporate continues to be engaged on finishing its acquisition of VMware (VMW) however within the meantime stays worthwhile whereas returning money to shareholders by way of dividends and share repurchases. But I make the case that AVGO is in its mature stage of its firm lifecycle and the present valuations usually are not presenting sufficient upside. Provided that I discover it tough for AVGO to generate the expansion essential to justify its a number of, I’ve bought out of my place and charge the inventory a maintain.

AVGO Inventory Value

AVGO is likely one of the few tech shares nonetheless buying and selling in any respect time highs. As I am going to talk about on this report, I discover that distinction to be misplaced.

I final lined AVGO in September the place I rated the inventory a purchase on account of the affordable valuation. Two quarters later, the inventory has returned greater than 20%, wildly surpassing even my most bullish expectations.

AVGO Inventory Key Metrics

In its most up-to-date quarter, AVGO delivered yet one more quarter of gorgeous development, with revenues rising 18% YOY and earnings per share rising by an analogous quantity.

As has been the case for a lot of quarters, these sturdy development charges have been pushed by semiconductor revenues because the software program revenues really declined by 1% YOY.

These sturdy numbers come after a 2022 yr wherein AVGO delivered the everyday double-digit prime and backside line development that buyers have come to count on.

AVGO ended the quarter with $39.3 billion of debt versus $12.6 billion of debt. The corporate repurchased $1.2 billion of inventory and has grown its dividend over the previous decade.

Wanting forward, administration has guided for the second quarter to see round $8.7 billion in income, representing 7.4% YOY development.

It’s exactly that deceleration in development charges that I imagine will take buyers unexpectedly as they might have come to count on AVGO’s historical past of double-digit development to be extra sustainable than it truly is.

Is AVGO Inventory A Purchase, Promote, or Maintain?

At first look, AVGO seems to be vastly underpriced. How usually do you get to purchase the inventory of a double-digit grower paying rising dividends and shopping for again inventory at 15x ahead earnings?

However that valuation a number of turns into extra comprehensible when one components in consensus estimates for low single-digit income development over the approaching years.

These consensus estimates might shock some readers, as AVGO has a historical past of rising its dividend at very speedy charges.

This is the issue: regardless of showing on the floor to being a cross between a {hardware} and software program firm, AVGO stays primarily a semiconductor enterprise topic to the everyday cyclicality of that sector. In the meantime, its software program enterprise is nothing to put in writing dwelling about as evidenced by the poor development charges. AVGO usually touts having a large product portfolio with a concentrate on cybersecurity.

However as a tech analyst protecting aggressive corporations, I can’t assist however level out that their endpoint safety providing in Symantec, which AVGO acquired in 2019, is extensively referred to as an incumbent being disrupted by the likes by extra fashionable rivals in CrowdStrike (CRWD) and SentinelOne (S). Not all tech is equal, and it is vitally tough to make the argument that AVGO is on the suitable facet of that coin.

What’s extra, AVGO represents what I wish to name a “fully-milked cow.” I’ve talked about that AVGO has accelerated its development charges over the previous a number of years by way of acquisitions. Professional-forma for the VMware acquisition, AVGO would see debt to EBITDA bounce to three.1x, a quite excessive ratio within the tech sector. Whereas many different tech corporations have many catalysts forward of them by way of juicing margins and ramping up leverage, AVGO has arguably already moved previous such catalysts. In any case, its adjusted EBITDA margin is already round 63% – how far more value optimization can actually happen right here? “It would not get higher than this” may be an applicable saying.

This brings me again to the valuation. Gradual-grower shares like AVGO aren’t unbuyable however the bulk of the upside usually comes from a number of growth. On the time of my earlier report, AVGO was buying and selling at 13x 2023e earnings. Now, AVGO is buying and selling at 15x 2023 earnings and people estimates have gone up by 3%. For a reputation projected to develop by a mid-single-digit charge transferring ahead, 15x earnings doesn’t look so low-cost, particularly contemplating the valuation reset that has occurred within the broader tech sector. Dangers have emerged relating to the corporate’s means to shut its acquisition of VMware, and AVGO wants this acquisition to assist bolster its ahead development charges (it’s also controversial that VMware represents yet one more slow-growing mature firm). I’m involved that many buyers may be proudly owning AVGO pondering that it’s a quickly rising secular development firm, holding that perception as a result of firm’s development charges over current years. However the actuality is that AVGO is a mature firm with a leveraged steadiness sheet and low projected ahead development. Provided that outlook, 15x earnings is presenting a value to earnings development ratio (‘PEG ratio’) within the 2.5x vary, however I’m discovering many tech shares with PEG ratios within the 1.2x vary and even decrease (a silver lining of a brutal interval for tech buyers). Because of this AVGO is buying and selling on the higher finish of its truthful worth vary, providing little hope for upside from a number of growth with the majority of its returns to return from its 6.7% earnings yield. In gentle of the poor risk-reward proposition, I’ve bought out of my place and charge the inventory a maintain.