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Summary

  • Broadcom has compelling valuation metrics and strong earnings growth prospects.
  • Broadcom will benefit from its decision to explore strategic alternatives for its cellular baseband business, including a potential sale or wind-down.
  • In my opinion, BRCM's stock has plenty of room to move up.

Broadcom Corp. (NASDAQ:BRCM) is an excellent combination of value and growth dividend stock. Broadcom will benefit from its decision to explore strategic alternatives for its cellular baseband business, including a potential sale or wind-down. Broadcom has compelling valuation metrics and strong earnings growth prospects; its PEG ratio of 0.76 is remarkably low, one of the lowest among S&P 500 tech stocks. Furthermore, BRCM's stock is ranked fourth among all S&P 500 tech stocks according to Portfolio123's "Balanced4" powerful ranking system. in my opinion, BRCM's stock has plenty of room to move up.

The Company

Broadcom is a global leader and innovator in semiconductor solutions for wired and wireless communications. Broadcom's products seamlessly deliver voice, video, data and multimedia connectivity in the home, office and mobile environments. The company was founded in 1991 and is headquartered in Irvine, California.

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Source: Broadcom at a Glance

Valuation Metrics

The table below presents the valuation metrics of BRCM. The data were taken from Yahoo Finance and finviz.com.

Broadcom's valuation metrics are very good - the company has a low debt to equity ratio, and the Enterprise Value/EBITDA ratio is at 15.22. According to Yahoo Finance, BRCM's next financial year forward P/E is very low at 11.44 and the average annual earnings growth estimates for the next five years is very high at 15%. Tese give an extremely low PEG ratio of 0.76, one of the lowest among S&P 500 tech stocks. The PEG Ratio - price/earnings to growth ratio is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.

Dividend

Broadcom has been paying uninterrupted dividends since January 2010. The forward annual dividend yield is at 1.29%, and the payout ratio is at 41%. The annual rate of dividend growth over the past three years was very high at 11.2%.

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Source: Charles Schwab

Since the company generates lots of cash (ttm price to free cash flow is only 14.96), and the payout ratio is low, there is a good chance that the company will continue to raise its dividend payment.

Latest Quarter Results

On July 22, Broadcom reported its second quarter 2014 financial results, which beat EPS expectations by $0.04 (6.56%) and missed the consensus on revenues.

Net revenue for the second quarter of 2014 was $2.04 billion. This represents an increase of 2.9% compared with the $1.98 billion reported for the first quarter of 2014 and a decrease of 2.3% compared with the $2.09 billion reported for the second quarter of 2013. Non-GAAP net income for the second quarter of 2014 was $406 million, or $0.65 per share, compared with non-GAAP net income of $318 million, or $0.51 per share, for the first quarter of 2014 and non-GAAP net income of $436 million, or $0.70 per share, for the second quarter of 2013.

In the report, Scott McGregor, Broadcom's President and Chief Executive Officer, said:

Broadcom performed well in the June quarter. We recently made the difficult but prudent decision to wind down our cellular baseband business and focus on the Broadband, Connectivity and Infrastructure markets. As a result, we will be a stronger company, as gross margins, profitability and cash flows will noticeably improve, providing an opportunity to return more capital to our shareholders.

Competitors

A comparison of key fundamental data between Broadcom and its main competitors is shown in the table below.

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Source: Yahoo Finance, finviz.com

Broadcom has the lowest forward P/E ratio and the lowest PEG ratio among the stocks in the group. However, its EV/EBITDA ratio is the highest.

Ranking

According to Portfolio123's "Balanced4" powerful ranking system BRCM's stock is ranked fourth among all S&P 500 tech stocks - only Xerox (NYSE:XRX), Alliance Data Systems (NYSE:ADS) and Western Digital (NASDAQ:WDC) have a higher ranking (see my SA article about XRX). The "Balanced4" ranking system is quite complex, and it is taking into account many factors like EPS consistency, technical analysis, valuation, profitability ratios and dividend information, as shown in Portfolio123's chart below.

Back-testing over 15 years has proved that this ranking system is very useful.

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The BRCM stock price is 1.66% below its 20-day simple moving average, 0.55% below its 50-day simple moving average and 19.56% above its 200-day simple moving average. That indicates a short-term and a mid-term downtrend and a long-term uptrend.

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Chart: TradeStation Group, Inc.

The weekly MACD histogram, a particularly valuable indicator by technicians, is at 0.27 and descending, which is a bearish signal (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 62.98 which does not indicate oversold or overbought conditions.

Analyst Opinion

Analyst opinion is divided, but most of them recommend the stock. Among the forty-two analysts covering the stock, twelve rate it as Strong Buy, twenty-one rate it as a Buy, eight rate it as a Hold, and one analyst rates it as an Underperform.

TipRanks is a website that ranks analysts according to their performance. According to TipRanks, among the analysts covering BRCM stock there are seventeen analysts who have the four or five star rating, eleven of them recommend the stock, five top analysts rate the stock as a Hold, and one analyst rates it as a sell.

On July 23,Cowen's analyst Timothy Arcuri increased its price target on Broadcom from $39 to $43 and maintains an outperform rating on the stock following Q3 results.

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Source: TipRanks

Major Developments

On June 02, Broadcom announced that it is exploring strategic alternatives for its cellular baseband business, including a potential sale or wind-down. The company has engaged investment bank JPMorgan in connection with its efforts.

Broadcom's strategic decision, which the company defined as difficult but prudent, seems to me positive for the company, since it will now focus on its Connectivity and Infrastructure markets which have better growth prospects. Furthermore, exiting its cellular baseband business would eliminate approximately $700 million in expenses.

According to Broadcom, the successful sale or wind-down of the cellular baseband business is currently expected to result in a roughly $700 million reduction in annualized GAAP research and development and selling, general and administrative expenses, of which approximately $100 million relates to estimated reductions in stock-based compensation

Broadcom has been able to show an earnings per share surprise in each one of the last four quarters, as shown in the table below.

Data: Yahoo Finance - Analyst Estimates

In my opinion, the fact that the company succeeds to beat analyst expectations quarter after quarter demonstrates the strength of its business, and there is a good chance that Broadcom will continue to surprise by reporting better than estimated results also in the future.

BRCM's stock has been doing well this year. Since the start of the year, BRCM's stock has gained 25.8% while the S&P 500 index has risen 4.5%, and the Nasdaq Composite Index has increased 4.7%. However, in 2013 BRCM's stock was a big loser with a 10.7% drop in the year, that compared to a gain of 29.6% for the S&P 500 index in 2013 and an increase of 38.3% for the Nasdaq Composite Index. Nevertheless, in my opinion, the current rally in its stock price should continue because Broadcom has compelling valuation metrics and strong earnings growth prospects.

Risk

Broadcom derives a substantial portion of its revenue from sales to a relatively small number of customers. Contributions to its net revenue by these customers have increased in the last several years. Sales to its five largest customers represented 48.3%, 46.9% and 42.3% of its total net revenue in 2013, 2012 and 2011, respectively. The loss of a key customer or design win, or a reduction in sales to any key customer, could seriously impact its revenue and materially and adversely affect its results of operations.

Conclusion

In my opinion, Broadcom will benefit from its decision to explore strategic alternatives for its cellular baseband business, including a potential sale or wind-down. Broadcom has compelling valuation metrics and strong earnings growth prospects - its PEG ratio of 0.76 is remarkably low, one of the lowest among S&P 500 tech stocks. The company generates lots of cash (ttm price to free cash flow is only 14.96), and it has raised its dividend payment by an average of 11.2% a year.

All these factors bring me to the conclusion that BRCM stock is a smart long-term investment.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in BRCM over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Broadcom: Buying Opportunity In A Growth Dividend Stock