Since the last time I wrote about Broadcom (BRCM), the share price of the company is flat, which is better than down. In this report, I add to the previous one with updated valuations and a portfolio analysis perspective. Simply said, Broadcom continues to be undervalued.
But not only is it undervalued, based on my analysis, I expect Broadcom to outperform the S&P 500 over the next 52 weeks. While the S&P 500 is forecasted to increase about 6% over the next 52 weeks, Broadcom is forecasted to increase 40%. The increase in the share price could be boosted by an increase in net income.
As net income increases, the amount of growth priced into the shares of Broadcom decreases. Consequently, the share price would rise to maintain the same level of growth expectations priced in the share price. Also, Broadcom is undervalued relative to its historic valuations.
For the long-term investors, I'm forecasting a revenue CAGR of about 6.25%, which means that your investment would almost double over the course of 10 years, if the price/sales multiple doesn't expand or contract and the revenue forecast is accurate. All of that said, I'm bullish on Broadcom.
In this section, I'm going to use a few models to value the common equity shares of Broadcom. I'll update the discounted cash flow model and the multiplier models. Also, I'll include an estimate of the market's growth expectations. The following data suggest Broadcom is undervalued.
In terms of discounted cash flows, I'm revising down my estimate of the intrinsic value of Broadcom using the discounted cash flow method. The cash flow estimates and growth rates remain the same: I continue to expect an 8% growth rate until a decline to the sustainable growth rate of 5% in 2018. But I revised the firm's cost of equity. As a result, I estimate the intrinsic value, using this model, of Broadcom as $19.07. Based on the current share price, the market is probably pricing in a higher growth rate than I am pricing. So, next I'll estimate how much growth the market is pricing into the share price.
When I use the twelve trailing months EPS, 65% of the market price is because of growth. That said, I adjusted the twelve trailing months EPS because of the $501 million impairment of purchased intangible assets charge. When I did that, 24% of the share price is because of growth, which is more reasonable. I think that number could increase to 40% without pricing in too much growth.
In comparison, investors were pricing in about a 22% growth premium into the share price of Qualcomm (QCOM). With that said, Qualcomm is trading near its recent high and Broadcom is trading well off of its recent high. It appears investors were pricing more growth into the share price of Broadcom than they were into the share price of Qualcomm. But the 10-year average revenue growth rates are roughly the same. Also, Qualcomm is the more profitable company and its business risk is substantially lower than Broadcom's business risk. Consequently, I think investors should be pricing more growth into the share price of Qualcomm than Broadcom. Next, I will do a 10 year revenue projection to see what the two companies' revenues could look like.
There is a strong linear correlation between Qualcomm's and Broadcom's revenues. In 2022, Broadcom is forecasted to have revenues of $14.8 billion; applying the current price/sales multiple of 1.9, the valuation would be $28.12 billion. Excluding dividends, the CAGR would be 6.28%. Qualcomm's revenues in 2022 are forecasted to be $31.2 billion; applying the current price/sales multiple of 5.0, Qualcomm would be valued at $156 billion. Excluding dividends, the CAGR would be 3.03%. Additionally, I'm not sure Qualcomm will continue to trade at 5 times sales; the multiple could contract.
Using the multiplier models, Broadcom is undervalued relative to its historic valuations. Also, the firm is undervalued relative to its recent trading history. Further, the valuations relative to the industry are compelling.
Investors may have been right to price more growth into the share price of Broadcom than that of Qualcomm based on the revenue forecast, but Broadcom does have a higher level of business risk than Qualcomm, which weighs on the valuations. When I look at the valuations in totality, I think investors should get long shares of Broadcom. Next, I'll do some analysis from a portfolio management perspective.
In terms of the return distribution, it is negatively skewed and the kurtosis is negative. So, at least the distribution has less fat tails than a normal distribution, but as investors we would prefer a positively skewed distribution.
That said, over the next year, I have a price target of $37 per share. The return would be about 40% over the next year, excluding the dividend payments. The return on invested capital would be excellent. If Broadcom's net income rebounds in the next 12 months, the return would become more likely. The valuations would support that kind of increase in the share price; so, from that perspective, a 40% increase in the share price could happen.
Since 2009, the correlation between Broadcom and the S&P 500 is 0.55. In other words, investing in Broadcom would provide some diversification. Additionally, the S&P 500 explains 30% of the variation in the share price of Broadcom. Lastly, I'm forecasting an S&P 500 price target of $1,800 over the next 12 months as less accomodative monetary policy could weigh on the broader market. Consequently, Broadcom should outperform the S&P 500 over the next 52 weeks.
Overall, from a portfolio analysis perspective, investors, including me, should be bullish on shares of Broadcom. Also, the valuations and the portfolio management analysis suggest being bullish on Broadcom.