Broadcom’s Profitability Paradox: Record AI Revenue Weighs on Margins

Broadcom US11135F1012

Despite delivering a powerful set of quarterly results, Broadcom shares faced a severe market sell-off. The disconnect highlights a pivotal shift in investor focus: the market is now scrutinizing not just if a company is growing, but how that growth impacts its fundamental profitability, particularly when fueled by the capital-intensive artificial intelligence sector.

In a stark reaction, Broadcom's stock closed Friday's session down 11.7% at €305.80. This single-day plunge erased a significant portion of the stock's recent gains, though the share price remains substantially higher for the year to date.

The catalyst was the release of the company's financial performance for its fourth fiscal quarter of 2025. On the surface, the operational metrics were robust:

• Revenue reached $18.02 billion, marking a 28% year-over-year increase.
• Adjusted earnings per share came in at $1.95, surpassing estimates of approximately $1.87.
• AI-related revenue surged 74% to $6.5 billion.
• The quarterly dividend was raised by 10% to $0.65 per share.

Even with this "beat-and-raise" performance, investor sentiment turned negative immediately after the report. The market's attention shifted away from top-line growth figures toward the underlying quality and cost of that expansion.

The AI Growth Engine Pressures Profitability

The core concern for investors centers on margin compression. While Broadcom's AI business—comprising custom accelerators and networking technology—is expanding at a breakneck pace, its gross margin percentages are lower than those of the company's established enterprise software segments.

Management's guidance for the first quarter of fiscal 2026 underscores this dynamic. They project AI revenue will nearly double to $8.2 billion. Concurrently, the company anticipates a sequential decline in its overall gross margin of approximately 100 basis points.

This shift in the product mix is what unsettled the market. The combination of capital-intensive hardware and slimmer margins has ignited fears of "hollow" growth—substantial revenue gains that deliver less profit per dollar. These concerns were amplified by similar discussions around high capital expenditure in the tech sector, notably at Oracle, during the same week.

Strong Forecasts Meet a Cautious Market

From a fundamental business perspective, Broadcom's outlook remains aggressive. For Q1 2026, the company is targeting revenue of about $19.1 billion, well above the prior consensus range of $18.3 to $18.5 billion.

This guidance is supported by sustained, high demand for custom AI accelerators (XPUs) and Ethernet switches. The company's backlog has grown to $73 billion, providing strong visibility for coming quarters.

On Wall Street, however, a different priority is currently dominating: margin stability is now being weighed more heavily than pure revenue growth. The substantial order pipeline is acknowledged, but not without a valuation discount applied to the company's altered profitability profile.

Analyst Perspective: Fundamentals Remain Sound

The view from research analysts presents a notably more favorable picture. Despite the sharp share price decline, several firms have raised their price targets. Cantor Fitzgerald, for instance, increased its target to $525, citing continued tailwinds from the AI segment.

This discrepancy between the short-term market reaction and medium-term analyst assessment suggests that a portion of the sell-off may be attributed to profit-taking following a rally of over 50% since the start of the year, rather than deep-seated doubts about the business model's structure.

Conclusion: The Cost of Expansion

Broadcom is entering a phase where its rapidly growing, but lower-margin, AI hardware business is diluting the company's historical profitability levels. Friday's pronounced stock drop was significant, yet it does not alter the fact that revenue, backlog, and dividend payouts are at record highs. The critical challenge for the coming quarters will be whether the company can successfully balance its now multi-billion-dollar AI operations, ensuring that high growth and solid margins can coexist in a sustainable model.