The S&P 500 and Nasdaq Composite have gotten off to red-hot starts so far in 2024, with each index already boasting double-digit returns.
It shouldn't come as a surprise that one of the biggest tailwinds fueling the capital markets right now is artificial intelligence (AI). Specifically, a collective of megacap tech businesses known as the "Magnificent Seven" have enjoyed some of the biggest gains so far this year.
Within the Magnificent Seven, shares of semiconductor company Nvidia are already up a sizzling 123% in 2024. A return of this magnitude might imply that investors just can't get enough of Nvidia, and perhaps it's too late to enjoy the ride.
But savvy investors understand that there are many other opportunities besides Nvidia in the chip market. Brad Gerstner is a hedge fund manager who founded the investment firm Altimeter Capital.
According to Altimeter's most recent filings, Gerstner actually trimmed his position in Nvidia by a nominal 6,515 shares during the first quarter. Moreover, Gerstner initiated a new position in a different semiconductor company, Broadcom (AVGO 0.71%).
Let's explore how Broadcom is performing, and what makes it a compelling opportunity for long-term investors interested in AI.
The current state of the AI revolution
Not all semiconductor businesses are the same. Nvidia and Advanced Micro Devices focus on the design aspects of graphics processing units (GPUs) used for generative AI applications. However, both of these companies outsource the manufacturing process of their chips to fabrication specialists like Taiwan Semiconductor Manufacturing.
Right now, I'd wager that the aspects of the semiconductor industry experiencing the most demand are chipmakers and data center service providers. Fortunately for Nvidia, the company sits at the intersection of both of these areas -- hence the company is witnessing record sales and profit growth each quarter.
While this is encouraging for Nvidia investors, diversifying your exposure to semiconductors more broadly may be a good idea. The reason? As time goes on, other aspects of the chip space will begin to see some momentum beyond just buying chips or data center services.
Image source: Getty Images.
How does Broadcom fit into the picture?
Broadcom specializes in network infrastructure.
If you've ever used a large language model (LLM) such as ChatGPT, you might notice that the answers to your prompts occasionally experience delays or stall out, resulting in an error message. The simple explanation for this is that LLMs process enormous amounts of data.
Moreover, depending on the sophistication of your input (the prompt entered into the LLM), the model may require strong network connectivity in order to complete the task. Broadcom specializes in this process. In other words, while Broadcom is not the poster child of the latest generative AI model, the company's expertise plays a major role behind the scenes relating to performance.
In addition to ChatGPT, some of the more commonly used LLMs include Alphabet's Gemini, Meta Platforms' Llama, and Amazon's Claude. While the pros and cons of each model are up for debate, all of them are fairly new. Given their nascency and the fact that big tech is still very much in the research and development stage of commercializing these products, Broadcom's services remain slightly protracted at the moment.
However, according to Research and Markets, the global addressable market for network and switching AI data center solutions is expected to expand at a compound annual growth rate (CAGR) of 38% between 2024 and 2029 -- reaching $19.4 billion by the end of the decade.
As secular tailwinds continue fueling the overall AI narrative, Broadcom's business should begin to see an uptick in demand as network connectivity continues to be a major source for data centers.
Is now a good time to buy Broadcom stock?
The chart below illustrates the price-to-earnings (P/E) ratio for a number of different types of chip businesses. With a P/E of 52, Broadcom is valued at a premium compared to many peers. This could suggest that there is a bullish undercurrent surrounding network solutions.
AVGO PE Ratio data by YCharts
A prudent approach to investing in Broadcom would be to use dollar-cost averaging. This strategy will allow you to buy shares over a long-term time horizon at varying prices. As a result, you can monitor Broadcom's growth curve over time, and benefit from opening a position during a period of outsize momentum.
While shares of Broadcom are indeed a bit pricey, I wouldn't balk at the valuation. AI is still very much in its early chapters, and I think Broadcom's role in the overall AI realm is still being uncovered.
