From darling of artificial intelligence to high-stakes gamble, how did Broadcom Inc.'s (AVGO.US) bubble burst?

Since December 2024, Broadcom Inc. (AVGO.US) has fallen by 42%, currently still 28.5% below its historical high. But the question remains: is this a buying opportunity? Looking at Broadcom Inc.'s peers, we see that its performance is not unique. It is just a part of the potential bursting artificial intelligence bubble. Broadcom Inc. has dropped 28% from its historical high, NVIDIA Corporation has dropped 25%, Qualcomm has dropped 39%, and AMD has dropped even 55% from its historical high, although AMD's decline began several months earlier when Broadcom Inc. was still growing. Broadcom Inc.'s stock performance is consistent with its peers, as the artificial intelligence bubble appears to be bursting, with many stocks related to the previous artificial intelligence frenzy (often leading to very high valuation multiples for these stocks) now rapidly declining. However, despite the significant drop in Broadcom Inc.'s stock price, the company has still reported excellent performance. In the first quarter of the 2025 fiscal year, the company's net revenue was $14.916 billion, a 24.7% increase compared to $11.961 billion in the first quarter of 2024. Operating income for this quarter surged to $6.260 billion from $2.083 billion in the same period last year, an increase of 201%. Diluted earnings per share even increased from $0.28 in the first quarter of 2024 to $1.14 in the first quarter of 2025, a 307% increase. Finally, free cash flow increased from $4.693 billion in the first quarter of 2024 to $6.013 billion in the first quarter of 2025, a 28.1% increase. We can also look at two different divisions. In the first quarter of 2025, the semiconductor solutions division had revenues of $8.212 billion, an 11.1% increase year-over-year. On the other hand, the infrastructure software division had quarterly revenues of $6.704 billion, a 41.1% increase year-over-year. Broadcom Inc.'s performance is growing rapidly, and its business is in good shape. What's more important is how the company will perform in the next few quarters and even years. Perhaps everyone would agree that the current market environment is extremely difficult and highly uncertain. And a highly uncertain period makes predictions even more difficult. Although we can hardly make accurate predictions for any company in the coming years, it is particularly difficult for companies like Broadcom Inc. The hype around artificial intelligence (especially generative artificial intelligence) has been ongoing for the past two years, driving semiconductor companies to achieve high growth rates. But when we look at Gartner's cycle of emerging technology hype, we also see that generative artificial intelligence has passed the peak of expected inflation and is heading towards a trough of disillusionment. The adoption cycle of new technologies (such as generative artificial intelligence) typically follows such a cycle, experiencing an exciting period with significant investment from many companies before the technology truly enters the mainstream, leading to a period of disillusionment. It is difficult to predict the future development of the artificial intelligence and semiconductor market in the coming years. When people realize that the proliferation of artificial intelligence is far beyond expectations, and some overly high expectations are not met as expected, the excitement we have experienced since the end of 2022 may fade, and disillusionment may follow. But even if we are confident that this excitement may fade, it is still difficult to predict the future growth rate of semiconductor sales in the next few quarters. Will the growth rate collapse completely? Will sales even decline? Or will the growth rate only slow down but still achieve double-digit growth rates? News reports like Microsoft Corporation exiting some data center projects may just be rumors because companies changing plans are not uncommon. But it could also be a sign of impending dangerit's hard to say. Since high-growth emerging markets are always difficult to predict, and the sales of artificial intelligence in the coming years have become unpredictable, the situation is also more complex and risky for investors. The tariffs announced in early April (subsequently suspended again) will have huge consequences for the global economy, for several reasons. The chart above may give us an initial understanding of the extreme level of current tariffsespecially compared to the past few decades. A U.S. economic recession is almost inevitable. The chart shows the capital expenditure growth of Alphabet Inc. Class C, Amazon.com, Inc., Meta, and Microsoft Corporation, especially in artificial intelligence infrastructure, which has driven growth for Broadcom Inc. and other semiconductor companies. From the charts, JPMorgan expects capital expenditures to grow at a similar high speed in 2025. But what if these companies suddenly stop spending, for example, due to extremely high uncertainty levels and the need to retain cash and lay off employees due to declining profit margins? Although JPMorgan optimistically believes that the proportion of companies using artificial intelligence applications will further increase in the next six months, many companies are likely to suppress investment. Of course, the information industry still has growth potential, as currently only 24% of companies use artificial intelligence applications. But to achieve long-term high growth, other industries are equally important. I don't know if the construction, real estate, or entertainment industries in the United States will really view artificial intelligence spending as the best way to leverage operating cash flow (which may be much lower) during an economic recession. Companies like Broadcom Inc. will be heavily impacted by a potential U.S. economic downturn. During a U.S. economic recession, investments and expenditures are always lower, and currently many companies may not consider semiconductors as essential. Of course, companies will continue to update infrastructure, requiring semiconductors. But Broadcom Inc. needs high growth rates to support its stock price. High growth rates either need toLarge technology companies are increasing their spending, either needing other companies to also start investing heavily in the field of artificial intelligence.The final step now is to determine the intrinsic value of the stock. We first look at simple valuation multiples and also consider the price-to-earnings ratio, but the price-to-earnings ratio fluctuates greatly. As of the writing of this article, the stock's P/E ratio is 74 times, which seems not cheap (also higher than the 10-year average of 55.08). A better measure is the P/E ratio/free cash flow ratio, currently at 35.5. Although the P/E ratio/free cash flow ratio is much lower than its peak of 61 a few months ago, it is significantly higher than the 10-year average of 21.37. A valuation multiple of 35 times can only be justified by a long-term and sustained growth rate. Some companies can maintain such a high growth rate for the long term, and even with a valuation multiple exceeding 30 times, they can still be a good investment. However, we should always be very cautious when investing in these companies - caution should be exercised when investing in Broadcom Inc. at the moment. Furthermore, we always use discounted cash flow calculations to determine the intrinsic value of the stock. To achieve a reasonable valuation, the stock's annual growth rate for the next ten years must be around 22%, and the growth rate after that must be around 4%, until perpetuity. We can say that this more or less aligns with analysts' forecasts for the next few years, so Broadcom Inc.'s valuation can be considered reasonable. However, if the company can maintain such a high growth rate over the next 10 years, I would be very cautious and would prefer to believe that its current stock price is overvalued. Let's calculate the intrinsic value again (diluted shares outstanding 4.836 billion, discount rate of 10%). We can use the free cash flow from the past four quarters ($20.73 billion) as the basis for calculation. As of the writing of this article, Broadcom Inc.'s stock price is $180. If we remain optimistic and assume that Broadcom Inc. can achieve a growth rate of 6% over the next ten years, then the free cash flow for the next ten years must grow by 13% to 14%. At first glance, these growth rates seem reasonable. According to analysts' forecasts for the next few years, it is expected that the compound annual growth rate of earnings per share will reach 24.38% by the 2029 fiscal year, so maintaining low double-digit growth seems reasonable. However, these assumptions do not reflect the high risk of a potential economic downturn in the US, in which case analysts would not bet on a 24% annual growth rate. Furthermore, looking at the free cash flow profit margin, we find that 38% of revenue ultimately converts to free cash flow. This is not only higher than the average level of the past 15 years (31.7% free cash flow profit margin), but also very high, so should we use the free cash flow from the past four quarters as a benchmark? Finally, we can also question whether a 6% growth rate can be sustained. CFI not only advises against using a terminal growth rate greater than 4%, but also considering that the semiconductor industry itself is cyclical, we should also be cautious in assuming a high long-term growth rate. For Broadcom Inc., the current stock price may be reasonable. However, there are risks of a sharp decline in growth rates and overvaluation of Broadcom Inc. - especially in the event of a severe economic downturn in the US, the latter seems more likely to occur. It is difficult to answer whether Broadcom Inc.'s current valuation is reasonable and whether it is a good buy opportunity. Considering the high risk of a US economic downturn, the high likelihood of semiconductor sales (including AI sales) declining, and the still high valuation multiples of Broadcom Inc., analysts would be very cautious. This article is a translation from the WeChat public account "US Stocks Research Society", GMTEight editor: Chen Qiuda.