Broadcom’s AI Conundrum: Soaring Revenue Meets Margin Pressure

Broadcom US11135F1012

Despite delivering a robust quarterly performance fueled by artificial intelligence demand, Broadcom's stock is facing significant headwinds. Investors are shifting their focus from top-line expansion to profitability metrics, presenting the semiconductor giant with a critical challenge: demonstrating that compressed margins are a strategic trade-off for achieving a vastly larger scale of business, not a threat to its success story.

Broadcom's operational results for the latest quarter were undeniably solid. Revenue climbed to $18.02 billion, marking a 28% year-over-year increase and surpassing analyst expectations of $17.49 billion. Earnings per share also outperformed, coming in at $1.95 against a forecast of $1.86.

The market's reaction, however, has been decidedly cool. Shares recently closed at 290.35 euros, representing a decline of approximately 18% from levels seen just days prior. This sell-off appears less concerned with revenue growth and more focused on the outlook for gross profitability.

Company leadership explicitly noted that the rapidly expanding AI-related sales are exerting downward pressure on margins. The increasing proportion of custom AI chips in the product mix is projected to reduce the gross margin by roughly 100 basis points. This specific guidance is now applying substantial valuation pressure.

The Double-Edged Nature of AI Expansion

Broadcom's execution in the core AI segment remains impressive. Quarterly AI revenue surged to $6.5 billion—a 74% jump compared to the same period last year. Looking ahead, management anticipates AI semiconductor revenue could reach $8.2 billion in the first quarter of fiscal 2026, which would represent a year-over-year doubling.

This growth trajectory highlights a developing tension:

• Explosive Demand: Soaring orders from hyperscalers, including Google and Meta, are powerfully driving corporate revenue higher.
• Profitability Compression: The application-specific integrated circuit (ASIC) deals for these major clients carry lower margins than Broadcom's traditional software or networking product lines.

This shift in business profile is being critically assessed by investors. After reaching a record high near 415 euros, the stock plummeted by over 17% in a matter of days. It now trades about 7–8% below its 50-day moving average, though it remains comfortably above the 200-day line.

Analyst Confidence Endures Amid the Pullback

Despite the sharp share price decline, several major investment banks maintain a constructive view. They largely interpret the drop as a valuation reset rather than a breakdown in the company's fundamental story.

• JP Morgan designates Broadcom as a "Top Pick" with a price target of $475.
• Morgan Stanley raised its target to $462, citing a "very strong" long-term setup for the company.
• Bank of America increased its target to $500, placing particular emphasis on the strength of the AI order backlog.

Near-term volatility has increased markedly. The stock shows a 17.78% decline over a seven-day period, yet it retains a gain of roughly 27% over the past twelve months despite the recent correction.

A Massive Backlog Provides a Bullish Foundation

A central pillar of the optimistic thesis is Broadcom's exceptionally large AI-related order book. The company concluded the quarter with an AI-specific backlog valued at $73 billion. This figure constitutes nearly half of the total backlog, providing high visibility and predictability for revenue stretching into 2026 and beyond.

Management's confidence in the firm's cash-generating ability is also reflected in its capital allocation. The quarterly dividend was raised by 10% to $0.65 per share. Furthermore, operating cash flow remained robust at $7.7 billion. Even this positive news, however, was insufficient to immediately halt the selling pressure.

Outlook: Navigating Volatility with a Clear Challenge

The semiconductor sector is currently drawing a distinction between pure-play GPU providers and designers of custom chips. Broadcom's immediate task is to convince the market that absolute profit in dollar terms will continue to grow, even as the percentage-based gross margin contracts. As long as the share price trades significantly below its recent peak around 290 euros yet above its 200-day moving average, elevated volatility is likely to persist. All eyes will be on how the company manages the balance between explosive AI growth and its margin profile in the coming quarters.