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Broadcom Inc. (AVGO), another AI chip designer just like Nvidia (NVDA), announced on June 12 a similar 10-for-1 forward stock split which goes into effect in one month on July 15. Moreover, the company produced stellar quarterly results and increased its revenue outlook. As a result, AVGO stock still looks undervalued, despite its recent rise.
The shares are trading over $1714 early on Friday, June 14, up over 12% yesterday, and 30% higher than its June 3 close of $1,321 per share.
I wrote about how cheap it was in my May 12 Barchart article, “Broadcom Looks Deeply Undervalued Based on its Strong Free Cash Flow.” I wrote that AVGO stock was worth $1626 per share. Now, after its recent results, I believe it could be at least 18% more at $1,980 per share (i.e., $198 post-split).
Moreover, just like with Nvidia (see my June 5 Barchart article on NVDA), the upcoming AVGO stock split could make it easier to buy and sell (including selling short) AVGO puts and calls. That could help propel its valuation even higher.
Strong Free Cash Flow Margins
Broadcom's revenue rose 43% YoY to $12.487 billion, which was $476 million or 4% higher than analysts' expectations, according to Seeking Alpha. More importantly, the company raised its fiscal revenue guidance to $51 billion based on higher client demand for its AI chips, slightly higher, according to CNBC, than analysts' prior forecasts of $50.42 billion.
But here is what is important. Broadcom generated extremely strong free cash flow (FCF). It generated $4.48 billion in FCF, or 36% of revenue. Although this was slightly lower than the $4.38 billion it made last year, its FCF margin over the trailing 12 months (TTM) was very strong.
Based on my calculations, using Seeking Alpha data, Broadcom has generated $18.39 billion in TTM FCF on $42.619 billion in TTM revenue. That means that its trailing FCF margin has been very high at 43.15%.
This is useful since we can use that to project its FCF. For example, analysts now forecast that Broadcom's revenue will rise to almost $60 billion next fiscal year. This is up from prior forecasts of $57.67 billion, as I discussed in my last Barchart article.
As a result, using a 40% FCF margin estimate, its FCF could rise to $24 billion (i.e., 0.40 x $60b), or over 30% over the TTM FCF of $18.39 billion. That can help us set a price target for AVGO stock.
Price Target for AVGO Stock
For example, using a 2.5% FCF yield metric, that FCF estimate of $24 billion implies that Broadcom stock could be worth $960 billion (i.e., $24b/0.025). The reason is that assuming Broadcom were to pay out 100% of its FCF in dividends, the market would likely give AVGO stock at least a 2.5% dividend yield.
Given its present market cap of $781.5 billion, that implies that AVGO stock could rise another 18%. This sets the price target at $1,980 (i.e., $198 post-split).
Moreover, the company is buying back shares with its FCF (over $9.6 billion in the last 6 months alone). That helps reduce the share count and pushes the stock price even higher as its earnings and FCF per share rise significantly. It's possible then that the stock could easily be worth well over $200 per share post-split in the next year.
One way to play this is to sell short out-of-the-money puts.
Shorting OTM Puts
In my last article, I suggested selling short the $1,290 strike price put option expiring May 31 which was trading for $22.30, or a 1.73% put yield. A similar trade can be repeated for a similar high yield. Moreover, this will get easier to do once the stock split goes into effect.
For example, after the split, the investor won't have to secure as much cash at any out-of-the-money (OTM) strike price. Moreover, the level of premiums, given the lower stock price, will be lower on an absolute dollar basis.
For example, look at the $1,670 strike price put option expiring July 5, 3 weeks from now. It trades for $41.60 on the bid side, yielding 2.49% (i.e., $41.60/$1,670).
However, today an investor must secure $167,000 in cash and/or margin to do this short sale. This is because every put contract requires enough cash to sell 100 shares at the strike price. After the stock split goes into effect, the short seller will only have to put up $16,700 for one put contract sold short.
Granted the new regime will only bring in $41.60 per put contract shorted rather than $4,160 before the split. But at least the investor has more flexibility to increase the number of contracts they want to sell short to gain this income. After all, the put yield will still be the same.
The bottom line is that AVGO stock still looks cheap here even after its recent run-up. One way to play this is to sell short out-of-the-money (OTM) puts, especially for existing investors. This will get exponentially easier to do after the stock split goes into effect.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
