For the longest time, AVGO was only a so-so stock.

In the early 20-teens, prices for the stock then-and-now still known as Broadcom (Nasdaq: AVGO) bounced around in the single-digits, only breaking into the double digits in the second half of the second decade of this century. Even as recently as the early 2020s, Broadcom’s performance was only good, not great. From early 2020 to early 2023, the semiconductor stock roughly doubled in value.

Around about the that time, however, ChatGPT happened, and Broadcom stock has been off to the races ever since. From late 2022, when OpenAI first surfaced its large language model, through the end of 2024, Broadcom stock has more than quadrupled in value. Surfing the wave of investor enthusiasm for “AI stocks,” the stock’s price grew roughly four times as fast, over the last three years, as it did over the three years preceding.

AI or IE (Irrational Exuberance)?

Irrational exuberance, anyone?

I have to admit that this was my reaction to Broadcom’s amazing runup over the past few years. I mean, to an extent, Broadcom’s large stock price gains make some sense. Broadcom builds application-specific integrated circuits (ASICs) that its customers use for processing AI output. And AI itself is pretty great.

I use ChatGPT all the time myself (just not for writing articles) because, well, it’s useful and it’s free. And yet, doesn’t this raise some questions in your mind, as an investor in Broadcom stock?

Sure, it’s true that Broadcom has benefitted mightily from the AI revolution so far. Last quarter, sales grew a healthy 16% at Broadcom, and profits were up more than 172%. Still, if AI is the reason that Broadcom stock is going up, but AI is free for its users, then how does OpenAI, and how do all the other “AI companies” out there make the money they need to keep paying companies like Broadcom to build the chips that make AI happen?

Won’t Broadcom run out of steam at some point? And if so, then does Broadcom stock really deserve to sell for more than 176 times trailing earnings, as it does today?

Rational exuberance for Broadcom

Except here’s the thing: On the one hand, Broadcom’s 176 P/E ratio looks insanely expensive to me. But viewed from another perspective, Broadcom’s stock price, while expensive, isn’t quite as expensive as that sky-high P/E ratio makes it look.

Consider that, while Broadcom reported GAAP net income of “only” $5.9 billion over the last 12 months, the actual cash profits this business churned out over the same period, its free cash flow, amounted to more than three times that sum: $19.4 billion.

Valued on free cash flow, therefore, Broadcom stock sells for not “176 times earnings” but a much more palatable 55 times FCF. And yes, I understand that 55 times FCF is still a very large number. But when you understand that analysts who follow this semiconductor stock think Broadcom will grow its profits at more than 21% annually over the next five years, the stock’s valuation starts to look a whole lot more reasonable.

Look, I’m not going to sit here and tell you that “55 times FCF” is a bargain basement valuation. It isn’t. The way I usually calculate such things, dividing FCF by projected growth rate to arrive at a price-to-FCF-to-growth ratio, Broadcom stock scores an expensive 2.6. That’s a lot more than the 1.0 ratio I prefer to pay for most stocks as a value investor. It’s even higher than the 2.0 ratio which is my usual cutoff for selling a value stock that I own.

Still, two things can be true at once. Broadcom stock is more expensive than I’d like it to be. It’s also not nearly as overpriced as it looks just at first glance.

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