I tend to complain quite extensively about stocks that are not "appropriately discounted" enough to my liking. After arriving at chip giant Broadcom (BRCM), some of that seems to have changed. Because of the success of technology giant Apple (AAPL) and its seemingly never-ending story of growth, I have recently developed a sudden love affair with chip stocks.
The reason is simply that although Apple may be trending out of the price range of many investors, its famed "halo effect" has proven to be (on numerous occasions) very real. Add to that the fact that it has pushed the term "ecosystem" outside of chemistry classrooms and into the realm of technology, an effect that has shown to be remarkably profitable for several lesser-name companies.
As technology and the market as a whole transition and morph away from PCs and into smartphones and devices, it stands to reason that companies that contribute to this evolution should also benefit, even though their names are not implanted on the devices themselves. While Apple, and rivals Google (GOOG) and Amazon (AMZN), get all of the accolades, those in the back end, or for that matter, inside the cases, are silently growing revenue and margins.
Among the companies that stand to benefit from this growth, such as Texas Instruments (TXN), another name to now consider is Broadcom. But you don't have to take my word for it - it seems several Wall Street analysts already agree, with its highest target being $55. The question is, with so much coverage on the stock and with positive expectations, how much more good news can there be? In other words, with the stock up already 27 percent on the year, has all the good news been priced in?
Its recent quarter
On Tuesday, the company reported Q4 and 2011 earnings that topped Wall Street estimates. It earned an adjusted profit of 68 cents a share on revenue of $1.82 billion. Analysts had expected 64 cents per share, on revenue of $1.81 billion, according to a consensus survey by FactSet Research. To add more excitement to the call, the company issued sales outlook for the current quarter that also topped what analysts had projected.
J.P. Morgan analyst Harlan Sur said in a note: "Although management was reluctant to call a bottom in the first quarter, we believe there are enough areas of strength in the form of new product and program ramps that should enable Broadcom to drive growth in the second quarter and into the second half of the year."
The company's earnings as well as optimistic outlook is an impressive sign that the semiconductors are indeed on a rebound, considering how weak margins have been within the entire sector, which includes names such as Qualcomm (QCOM) as well as the aforementioned Texas Instruments. But as with all three companies, their link to Apple may serve as enough of a growth driver for the next several quarters and likely the rest of the year. In particular, of the revenue that Broadcom generates, Apple accounts for over 10 percent of that figure by the fact that it uses chips from Broadcom in all of its products on the market.
For Broadcom, as great as the outlook appears for the coming year when discussing its growth potential in smartphones and devices, there is another area in which it competes that is also due for a rebound. In following Cisco (CSCO) as much as I have, it should be noted that Broadcom is a formidable rival in the routing and switching space as well. This area has been down of late due to weak technology spending, but once it fully rebounds, the company's ability to steal market share should not be underestimated.
With a forward P/E of 11, the stock to me remains highly undervalued, and yet has room to grow when compared with Texas Instruments and Nvidia (NVDA). As with Intel (INTC), both companies pose stiff competition for Broadcom and should be perceived as a risk. But this is nothing new and a concern the company can easily navigate as evident by its recent earnings and stellar outlook.
Disclosure: I am long CSCO.