Broadcom: This Beaten-Down Tech Stock Is Too Cheap To Ignore

| About: Broadcom Limited (AVGO)

Buying when investors are extremely bearish and "giving up" can be hugely rewarding. Just consider how bearish (and wrong) investors were when they were selling stocks like Bank of America (NYSE:BAC) for about $7, or Hewlett-Packard (NYSE:HPQ) at around $11. Both of those companies were reporting disappointing news when the share prices reached those levels, but investors who bought into the negativity were extremely well rewarded as both of those stocks have at least doubled in less than a year.

One of the best times to go bargain-hunting is when a stock declines after financial results are reported. When investors are either expecting too much or when a company fails to deliver short-term results, the share price can tumble and give investors a fantastic buying opportunity. For example, tech stocks like Google (NASDAQ:GOOG) and Oracle (NYSE:ORCL) recently saw a sharp pullback after financial results were reported and it only took a matter of days before those stocks saw a sharp rebound off the lows.

This strategy works because it is based on supply and demand. When an "event" like a financial report is released, it can trigger a significant (but short-term) surge in trading volumes that can last for a couple days or so. This temporarily creates an extra supply of shares for sale as some investors capitulate and "give up" in the short term. However, this additional supply of shares being sold typically fades within days and trading volumes return to more normal levels. As the supply of shares being sold dwindles away, the stock price often sees a sharp rebound and this is why investors can see quick gains by buying these pullbacks. With this in mind, here is a closer look at Broadcom, which recently declined after earnings were reported:

Broadcom Corporation (BRCM) shares were trading around $35 in July, but then plunged to just over $27, after the company announced earnings and guidance which disappointed some investors and analysts. While it is easy to get disheartened when a stock drops, it can often pay to buy when others are selling. For example, tech stock bellwether Oracle saw a sharp drop and the shares even traded below $30 after it recently reported financial results. However, it did not take long for investors to see the value and the shares now trade for about $32. Fast-thinking investors who bought Oracle for about $30 or slightly less (on the post-earnings pullback) ended up with gains of about 7% in just a couple of weeks. Broadcom has a lot going for it, and for a number of reasons, it could also see a similar rebound in the coming days and weeks.

Broadcom designs and manufactures specialized chips, which are frequently used in some of the world's most popular smartphones, tablets and other mobile and electronic devices. This company even supplies Apple (NASDAQ:AAPL) with chips as well as a number of other smartphone makers. As we all know, the investor "honeymoon" with Apple has faded and that has pushed down valuation for Apple and many of its suppliers. However, Apple is expected to introduce some new products in the second half and beyond and this could renew investor interest in Apple and its supply chain. Future products that could include Broadcom chips might range in everything from wearable technology like an "iWatch," to new iPhones with larger screens or iPhones with lower price points, which could target emerging market consumers. Investors who are not excited about Apple's recent financial results, (which show a slowdown in growth), could completely change their tune if they see people waiting in long lines for new Apple products later this year. What's good for Apple, could be great for Broadcom, but there are other reasons to consider this beaten-down stock now:

1. For the second quarter of 2013, Broadcom posted solid financial results with non-GAAP net income of $436 million or 70 cents per share. Revenues came in at $2.09 billion, which was up about 6%, year over year. However, without adjustments, the company reported a GAAP net loss of $251 million or 43 cents per share. This loss is due to an impairment charge of $501 million or 87 cents per share from the recent acquisition of NetLogic Microsystems, Inc. However, investors should not get overly discouraged about this as it is a one-time charge. On the positive side, management expects gross margins to improve slightly for next quarter and revenues to come in at about $2.05 to $2.2 billion. An article dated July 24, 2013, from Zacks Equity Research states some other positives:

Broadcom expects a steady momentum in broadband in the coming quarters, driven by more market penetration in emerging markets and new technology adoption in developed markets. As for the Infrastructure & Networking segment, the company is bullish about the data center market and expects the strength in connectivity solutions in Mobile & Wireless segment to remain intact as well.

2. Broadcom has a very strong balance sheet with about $2.47 billion in cash, and only around $1.7 billion in debt. This financial strength reduces risks for investors and it gives the company plenty of flexibility in terms of spending on research and development, acquisitions, marketing and more.

3. Analysts expect this company to earn about $2.75 per share in 2013, and $2.86 per share for 2014. This puts the price-to-earning ratio at just around 10 times earnings. This is a significant discount to the market since the S&P 500 Index (NYSEARCA:SPY) currently trades for nearly 16 times earnings.

4. Broadcom has the potential to be a solid dividend growth stock. This company started paying a dividend to shareholders in 2010 at the rate of 8 cents per share on a quarterly basis. It has been raising the dividend slightly every year since, and it now pays 11 cents per share. That might not sound exciting to go from 8 cents in 2010, to 11 cents now, but let's not forget that this represents a nearly 40% increase in just about 3 years. Furthermore, with earnings expected to come in at almost $3 per share for this year and with the annual dividend at just 44 cents per share, this represents an extremely low payout ratio of just about 15%. That means the dividend looks very secure and the company has plenty of room to continue with annual increases to this payout.

5. While some investors seem decidedly bearish with Broadcom shares at just around $27, multiple analysts see significant upside potential. For example, on July 24, 2013, analysts at UBS (NYSE:UBS) reiterated a buy rating with a $35 price target. Analysts at Mizuho have a neutral rating and a $35 price target. Finally, analysts at Cowen have an outperform rating and a $37 price target. Investors who buy at about $27 now, could end up with gains of nearly 40% if Broadcom shares hit that $37 price target.

There are some downside risks to consider, which include the fact that many tech products like specialized chips can be vulnerable to technological obsolescence or rapidly changing dynamics due to consumer preferences. Another factor to consider is that when a company has a few major customers like Apple (for example), a loss of orders from that company could be very significant and negative on future financial results. However, Broadcom has successfully managed these challenges in the past and with the shares trading near 52-week lows, the risk-to-reward ratio seems very compelling.

Key Data Points For Broadcom From Yahoo Finance:
Current Share Price: $27.30
52-Week Range: $26.58 to $37.85
Dividend: 44 cents per share, which provides a yield of 1.6%

Data sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.

Disclosure: I am long BRCM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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