Broadcom - A Fundamental and Historical Valuation

🖥️ Business Overview

🎯Key Metrics

Total: 10/17

• +2 ✅✅ Projected Operating Margin: 55.54%
• +2 ✅✅ Projected 5-Year Revenue CAGR: 23.77%
• +1 ✅ Last 5-Year ROIC: 13.80%
• +1 ✅ Estimated Cost of Capital: 12.51% (less than ROIC)
• -1 ❌ Last 5-Year Shares Outstanding CAGR: +3.78%
• +2 ✅✅ Projected 5-Year EPS CAGR: 31.35%
• +1 ✅ Projected 5-Year Dividend CAGR: 14.28%
• +1 ✅ Moody's Rating: A3
• +2 ✅✅ Morningstar Moat: Wide
• -1 ❌ Morningstar Uncertainty: High

Broadcom demonstrates exceptional business metrics. Presenting high growth, high margins a wide moat and in a promising industry. The only thing to point out is the dillution of shares during the last couple of years, resulting in a tinier slice of pizza for each shareholder and also its High Uncertainty rating given the volatile nature of the semiconductor industry, one that can offer significant upside but also considerable competitive and cyclical risks.

📈Business Valuation

To calculate the intrinsic value of the company I'll use multiple methods:

• Discounted Cash Flows (DCF) - Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value;
• EPS Growth - the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/E - we assume mean reversion to the historical PE values.

I'll give more weight to the DCF and EPS methods, and only then the historical one. Giving the changing landscape of the world in general and the volatile nature of the company and industry, we should not assume that mean reversion to historical values is guaranteed.

Cost of Capital

I've used the latest annual financial statements of the company, the 10-Year US bonds as the risk free rate, the company Moody's rating and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity.

Cost of Capital: 12.51%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I've used: Cost of Capital - The Fair Value Journal. It is and will ever be completely free :)

Discounted Cash Flows (Weight: 45%)

I've used the latest and annual financial statements of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth - I'm using the risk-free rate (10-Yr bonds of US), because long term the company should not grow more than the rate of the economy. I'm using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Terminal Cost of Capital - I'm assuming that the company starts at the previously estimated cost of capital and then will converge gradually to the average cost of capital of its industry;
• Initial and Terminal Tax Rate - Given the volatility of the company's effective tax rate over the last couple of years I've set it to the industry average.

All the other inputs were taken or from the financial statements or from analyst projections.

The DCF gives us an estimated fair value of 175.27 dollars for Broadcom.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above Broadcom seems to be overvalued because even on the higher end of the simulations (P90) its DCF estimated fair value is still very low compared to the current company's price.

Given the fact that its current market price is well above P90, we can extrapolate that there's more than 90% probability that the stock is overvalued at the current prices. As always, let's take note and move on to the next valuation method before pulling (or not) the trigger, this way we'll have a much more clear picture of the current valuation of the company.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF - The Fair Value Journal

EPS Growth (Weight: 35%)

For this valuation method, I've used the current EPS and the analysts estimates of EPS growth. I also assumed a 35 PE for Broadcom, so a little below it current averages.

Then again, I used the Monte Carlo simulations to check how the estimated fair value changed as my assumptions were modified.

Using this method, Broadcom that is currently priced at 351.71 dollars, seems to be undervalued, being currently valued well below P10. Given this, we can extrapolate that there's 90% probability of Broadcom being undervalued.

This is clearly a contradiction from what we've seen previously on the DCF. It's because of that that we use a weighted average at the end with different weights for each valuation method.

Let's continue to the historical valuation to elucidate us a little more (I hope).

As before, feel free to try this yourself: EPS Growth - The Fair Value Journal

Historical P/E (Weight: 20%)

The current Price To Earnings (P/E) ratio is above its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical norm of 56.36 (still very high in my opinion) we can assume a fair value of 253.82 dollars.

Again, very different from both DCF and EPS Growth valuation methods. Right in the middle.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation - The Fair Value Journal .

✍️Summary

Now that we did all the heavy work, let's take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I feel more comfortable going with a fair value of 258.71 dollars for Broadcom given its volatility and all the differences between the valuation methods.

Please remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

However, overall, Broadcom seems to be overvalued despite its good fundamentals.

Fair Value: 258.71 dollars