This Tech Stock Could be Ready to Bounce Again

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With all due respect to famed economist Burton Malkiel, but stocks don't make a "random walk." His famous book from 1973, A Random Walk Down Wall Street , opined that the stock market incorporates all information and there is no such thing as an overvalued or undervalued stock. Yet time and again, we've seen perfectly good companies have their stocks tossed out when investors indiscriminately sell shares . These downdrafts give investors an opportunity to add to their position in a great company if they already own it, or re-enter into a position if they've already booked profits in the stock before.

That's surely the case with chip maker Broadcom (Nasdaq: BRCM ) , which zoomed well higher after I recommended shares in late December . The stock, which had traded under $30 when the year ended was on the cusp of moving into the low $40s in late March.


 
But the renewed market weakness has forced Broadcom to disgorge much of its gains. I still see this stock moving into the mid-$40s -- or higher, and see the pullback as a fresh entry point.

Catalysts galore
It's not enough to simply note that a stock is inexpensive. You have to find events that will bring investor attention back to a stock. And Broadcom has plenty of these.

It starts with 802.11ac, which is the name of the newest and fastest Wi-Fi protocol, enabling computers, smartphones and other devices to send large streams of data at a very high-speed. Look for a major upgrade cycle for this Wi-Fi technology to begin in the next few months, and Broadcom's chips will be at the heart of many of these devices.

The biggest driver: TV sets. Starting this summer, many new TVs will be able to act like Internet access devices, streaming information from wireless routers right onto the screen. Manufacturers hope this will trigger an upgrade cycle for TVs after several years of weaker-than-expected sales.

Another key catalyst: Broadcom's systems-on-a-chip approach should yield solid results later this year. Smartphone makers want their phones to be thinner and lighter, while also consuming less power. By putting a number of capabilities onto one chip, Broadcom has been able to secure dozens of design wins and should see rising revenue streams as the next generation of phones hit the market.

But this isn't about just smartphones and TV sets. Broadcom is at the heart of the entire communications equipment landscape. Its chips go into wireless base stations and should also play a key role in upgraded Ethernet and data-transport networks.

Perhaps my top reason to pick up this stock on sell-offs is the pristine cash flow statement . Since I looked at this stock in late December, the company went on to report free cash flow that is even more robust that I thought.
 
Broadcom has always maintained low costs by outsourcing manufacturing to other chip foundries), which has enabled the company to generate a rising tide of free cash flow.  In fact, average capital spending of around $105 million in each of the past four years is pretty amazing for a company with nearly $8 billion in sales. The "asset-light" business model allows Broadcom to focus its resources among its hundreds of engineers. The company spent $2 billion in research and development last year, which sets the stage for further chip innovations in the years to come.

Risks to Consider: Chip-making can be fiercely competitive, so rivals may trigger price wars to defend or take market share .

Action to Take --> The pullback in this stock came at a time when Broadcom delivered solid first-quarter results and issued guidance above analysts' forecasts. Whereas analysts had been expecting roughly $1.85 billion sales in the current quarter, Broadcom now says this figure could be at least $1.9 billion and perhaps even nearly $2 billion.

This tells you the sell-off is more about the market and not about company-specific concerns. Shares now trade for about 10.5 times projected 2013 profits. This stock has only rarely gone below 10 times forward earnings in the past, and the current multiple has often represented a solid entry point for investors. History could be repeating itself. Merrill Lynch notes that Broadcom's peers are valued at between 14 and 20 times forward earnings. The stock would have to shoot up by about 40% just to get into this neighborhood, which is easily doable.

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-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas

Referenced Stocks: BRCM

David Sterman

David Sterman

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