Broadcom Could Fly Higher With Increased Tech Profits

Apr.21.11 | About: Broadcom Limited (AVGO)

To continue from my Technical Analysis of Broadcom (BRCM), let's now look at some fundamental data. Simply stated, Broadcom creates computer chips and parts, and sells them to the businesses that want to use them in their products. Some of the companies that use Broadcom's products include: Apple (NASDAQ:AAPL), Motorola (NYSE:MMI), Cisco (NASDAQ:CSCO) and Dell (NASDAQ:DELL). Overall, Broadcom's products are used very broadly over many tech companies, so its performance isn't tied to just one company or business; but it thrives when technology thrives, and may have slow downs when tech has slow downs.

Looking at its current value of about $20.5 billion, with a P/E ratio of 19.2, this company may seem very fairly valued. But, as is the case with many tech companies, growth is where the great potential lies, and Broadcom certainly has the potential for growth - especially as its customers produce more products, or they continue to have strong demand for the items they are already producing.

Over the past year, Broadcom's return on equity was 22.3%, and its return on invested capital was 20.3%, which are both very strong numbers that indicate some impressive growth happened in the past year. Additionally, these are both much higher than their five year averages of 9.7% and 9.4%, respectively, which indicates that demand has picked up for the company's products. A 15.9% profit margin also indicates some very healthy product demand, with plenty of profit to be gained from this increased demand, and any more that comes along.

Analysts estimate a 16.25% earnings growth for each of the next five years, which seems consistent with the over 20% returns Broadcom has seen over the past year. Since the tech sector appears to be growing again, each of the companies giving products directly to the consumer will need more of Broadcom's products; and as Broadcom grows, it may well be supplying more of these products to its own customers, which could cause it to continue to grow strongly for some time.

Assuming that this 16.25% growth is accurate, and a conservative P/E ratio of 18, Broadcom's shares should be worth about $76 in five years, which is almost double their current price! Assuming the shares were purchased at $38 each, that would result in almost 15% returns for each of those 5 years, neglecting dividends! That's not too shabby. And considering that Broadcom is a more diversified investment in the first place, since it supplies its products to many different companies, it could be considered a less risky investment as well.

Overall, with a strong profit margin, high returns on equity and invested capital, and a good growth outlook, I believe that Broadcom is a good investment at these levels. Considering the huge demand for technologies of all kinds that seem to be increasing at an immense rate, I wouldn't even be surprised if Broadcom as a supplier grew faster than a lot of the companies it is supplying! And, by investing in it, we can ride the gains from increased technological demand without as much downside if a single product should fail, as Broadcom supplies many different companies.

Additionally, due to this diversity, I could see Broadcom eventually becoming a consistent, strong dividend paying company; but I think we still have a good bit of growth to go through before that.

-Update on "Technical Analysis of Broadcom": It appears that shares broke past the $39.29 resistance level in trading yesterday, and were up significantly more during after hours trading. This could mean that Broadcom is making a strong upward move along with the rest of the tech stocks due to Apple's earnings.

We'll see what happens.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BRCM, AAPL over the next 72 hours.