No chipmaker is benefiting more from the rapid growth in artificial intelligence (AI) spending than Nvidia. (NASDAQ:NVDA). The company’s graphics processing units (GPUs) are essential for companies looking to develop and train large-scale language models and build generative AI applications.
Nvidia leapfrogged the $1 trillion milestone in May 2023. Since then, it has more than tripled, making it one of only three companies with a market capitalization of more than $3 trillion. But Nvidia isn’t the only company whose market capitalization has skyrocketed as AI spending soars. In fact, advances in AI are virtually inseparable from the success of nearly every company valued at more than $1 trillion. This newest member, which both complements and competes with Nvidia, is no exception.
The latest artificial intelligence chip stock to join the trillion dollar club is Broadcom (NASDAQ:AVGO). The stock surpassed a milestone following an impressive fourth-quarter earnings report on December 12th. Here’s how the company became a major AI chip maker with a 13-digit valuation.
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Broadcom is a diversified business. It has an enterprise software division led by VMWare and Symantec. The company also makes semiconductors for applications such as wireless telephony, WiFi, and Bluetooth. But what’s really driving the business are two specialized semiconductor applications: network chips and AI accelerators.
Broadcom networking chips are essential infrastructure for AI data centers. Hyperscalers are paying billions of dollars for Nvidia’s GPUs, but they need Broadcom’s chips to get the most out of their processing power. Broadcom’s Tomahawk and Jericho switches ensure fast and efficient movement of data from one server to another. This means less processing redundancy and downtime. And when you’re trying to get the most out of billions of dollars worth of chips, every second counts.
No other company can match Broadcom’s technology when it comes to developing these chips. Additionally, no hyperscale data center manager would risk his job by switching to a competitor’s product, no matter how much money it could save the business. So Broadcom’s business has grown exponentially as data centers have installed more and more expensive GPUs and other chips in server racks.
Even more promising is the custom AI accelerator business. These are the next generation of AI chips.
Broadcom is working with several companies to develop purpose-built AI chips for data centers. The company’s three biggest customers are Alphabet, Meta Platforms, and TikTok’s parent company ByteDance. Management estimates that these three companies will have an addressable market of $60 billion to $90 billion by 2027. Considering the potential benefits for all three companies from advances in AI, the upper bound of this figure seems more realistic than the lower bound.
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Management also announced that it has signed agreements with two new customers to develop their own next-generation chips. Broadcom hasn’t released any details, but many believe those customers are Apple and OpenAI.
Apple is familiar with Broadcom’s efforts. We trained Apple Intelligence using Google’s TPU. Apple’s extensive efforts to build AI into its devices at the system level could soon make it Broadcom’s biggest customer. This leaves significant upside to management’s addressable market outlook, which does not include new customers.
Indeed, Broadcom appears well-positioned to benefit from maturing developments in artificial intelligence with its networking chips and AI accelerators. Going forward, management plans to split semiconductor reporting into AI and non-AI segments. Growth in the former will likely drive overall business performance for the foreseeable future.
Even though the stock price soared more than 24% after the company announced its fourth quarter results, the business outlook remains strong enough to justify the current stock price.
Management’s addressable market outlook of $60 billion to $90 billion represents a compound annual growth rate of more than 60% for the AI semiconductor segment. And with the addition of two potential new customers, the growth rate could increase significantly by 2027.
Although AI semiconductors are only a small part of Broadcom’s business today, they are a driving force in Broadcom’s future. Even after AI sales triple in 2024, management still expects AI chips to account for about a quarter of the company’s total revenue in the first quarter of 2025. But as AI chips become a bigger part of Broadcom’s business and continue to grow rapidly, this pace should keep the company’s revenue growth strong for a very long time. Analysts currently expect earnings to grow 28% next year and 20% in 2026.
As a result, investors should be willing to pay a premium valuation today for a stock that is already growing earnings at a high pace. As of this writing, the stock trades at approximately 36 times forward P/E. This is definitely a premium price and investors should consider the risk of investing at this price. Specifically, spending on AI may not continue at the breakneck pace seen over the past two years. However, the stock was trading at a similar valuation in early 2024, and management just showed why it was worth the price then. Investors looking for an alternative to Nvidia may want to consider Broadcom for their portfolio.
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Suzanne Frey, an Alphabet executive, is a member of the Motley Fool’s board of directors. Randi Zuckerberg is a former head of market development and spokesperson at Facebook, sister of Meta Platforms CEO Mark Zuckerberg, and a member of the Motley Fool’s board of directors. Adam Levy has held positions at Alphabet, Apple, and Meta Platforms. The Motley Fool has positions in and recommends Alphabet, Apple, Meta Platforms, and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
Nvidia Introducing the Latest Artificial Intelligence (AI) Chip Stocks to Join the Trillion-Dollar Club was originally published by The Motley Fool.
