Broadcom: To Buy or Not to Buy?

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 Broadcom (NASDAQ: BRCM) has earned a reputation for technological innovation and excellence, but it was not enough to protect its stock from a serious decline after its second quarter earnings release on July 24. Less-than-stellar results from the company’s wireless chip segment and lower guidance sent investors to the exits, dropping the share price about 15%.

Rumors abound that both Apple and Samsung plan to produce their own chips or are switching to Qualcomm (NASDAQ: QCOM) products. Following the earnings release, Broadcom received a hefty seven analyst downgrades for its stock. Broadcom is still the industry leader in mobile wireless, but the company looks like a marginal player in the baseband and application processor market with about 4% market share.

In this article, I aim to deliver a clearer picture on where Broadcom currently stands. Our argument makes a largely statistical case for suggesting whether or not this stock is a smart bet for your profits. 

Financials and stock performance

Broadcom’s net revenue and earnings per share were positive, with revenue up 6% year over year and earnings per share at $0.70, above analyst estimates. Due to the acquisition of NetLogic and other charges related to the deal, earnings came in at a loss of $0.43 per share.

The company gets upward of 45% of its revenue from mobile wireless. It is hardly surprising that investors get nervous when Broadcom reports poor results and analysts expect potential loss of market share to its competitors.

Broadcom’s direct competition is with Qualcomm Atheros, a subsidiary of Qualcomm. Although Intel (NASDAQ: INTC) has been a preeminent force in the semiconductor industry for decades, the company focused its chip technological expertise on the PC segment and largely ignored the mobile market until recently.

 Intel operates in intensely competitive industries, with a high percentage of fixed costs and product demand that is highly variable and difficult to forecast. Revenue and the gross margin percentage are largely affected by the timing of Intel product launches, the demand for and market acceptance of Intel's products. By contrast, Intel's chips typically cost five times what Qualcomm chips for the mobile market sell for. 

While Broadcom’s stock price fell by close to 17% year-over-year, Qualcomm and Intel are both up with about 14% and 15%, respectively. Broadcom’s outsized 38.5 price-to-earnings ratio for the trailing twelve months makes the stock look like a poor bet for value investors. However, the forward price-to-earnings, price-to-book, and price-to-sales ratios show that Broadcom has better numbers than its two competitors.

Although Broadcom’s low return on equity is worrisome, the number for 2012 was a more attractive 10.01%. The value that jumps off the table is the three-year average net income growth of 122.5%, which is far superior to its competitors. Broadcom has gained from the outsize success of both Apple and Samsung, both of whom use Broadcom chips exclusively. What is important is not only past performance, but future growth.

What does the future hold?

Technological innovation moves so rapidly that high tech today is already old tech tomorrow. Investors fret that Broadcom is in trouble due to its potential loss of market share in these applications. Some analysts already consider smartphones and tablets “rear view mirror” technology.

The next big reasons for a lot of buzz are wearable computing devices and home networking. Google's wearable Google Glass is already being market tested, and the Silicon Valley Business Journal recently reported that Mercedes Benz is looking to incorporate the technology in its navigation systems. Apple investors anxiously await any news about the coming of the iWatch as well, though some skeptics question the market potential of wearables.

No one is questioning the future of the "connected home," however. It is already beginning, with changes in media consumption via home televisions. Google recently demonstrated а game-changer – its Chromecast plug-in unit that allows content streaming on a home television from multiple sources. A recent post in Forbes Online reports that provided a teardown analysis of multiple streaming devices performed by the website ifixit.com revealed both Broadcom and Qualcomm Atheros to be key suppliers of chips and connective technologies.

Intel’s new Bay Trail-T SoC is ready for official launch on Sept. 11, 2013. The new SoC will give manufacturers plenty of time to come up with cheap x86 tablets in time for the holiday season. In addition, Intel has started building its first dedicated facility for 450 mm wafer production. The company's new foundry - D1X Module 2 - will come online in 2015 and will cost $2 billion. The capabilities of the new facility could give Intel a significant competitive advantage, however.

Summary

Investors considering Broadcom a stock to buy need to keep their eyes on two things: firstly, the wirelesses connectivity market and, secondly, any news about Broadcom agreements and other improvements in home networking.

Evaluating technology stocks is a challenging proposition for the lay person who may not have the time or the inclination to learn the differences between broadband, baseband, and other technological terms. It is not too difficult to stay abreast of technology innovations like those going into connected homes and connected cars, however. With the potential market size of connected homes and connected cars,  Broadcom might find a room for future profitable growth.

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Marina Avilkina has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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