Broadcom Dips 6% Post Q2 Earnings: Is the AVGO Stock Still a Buy?

Broadcom (AVGO) shares fell 6% despite Q2 earnings and revenue beats, driven by AI chip and VMware strength; Q3 revenue guidance of $15.8B suggests 21% year-over-year growth, with AI revenue expected to rise 60% to $5.1B. However, gross margin is projected to decline 130 basis points sequentially due to a higher mix of lower-margin custom AI accelerators (XPUs), which are in high demand from hyperscalers like Alphabet and Meta Platforms, potentially pressuring margins throughout fiscal 2025.

Analysis

Broadcom (AVGO) reported strong fiscal Q2 2025 results, with earnings of $1.58 per share beating estimates by 0.64% and revenues of $15 billion surpassing consensus by 0.37%, primarily driven by a 46% year-over-year surge in AI semiconductor revenues to $4.4 billion and continued momentum in its VMware business. Despite these positive results, the stock declined 6.2% post-announcement, likely reflecting concerns over fiscal Q3 guidance which, while projecting 21% year-over-year revenue growth to $15.8 billion (including an expected 60% YoY jump in AI revenues to $5.1 billion), also signaled a sequential gross margin compression of approximately 130 basis points and noted sluggishness in server storage, wireless, and industrial segments. This margin pressure is attributed to an increasing mix of lower-margin custom AI accelerators (XPUs), for which demand from key hyperscalers like Alphabet and Meta remains robust, with XPU revenues growing double digits year-over-year in Q2. Broadcom's AI networking portfolio also showed significant strength, with revenues up 170% year-over-year, now constituting 40% of AI revenues, bolstered by innovations like the Tomahawk 6 switch. The company maintains a strong financial position, with $9.47 billion in cash, $6.41 billion in Q2 free cash flow (43% of revenue), and active capital return programs, having paid $2.8 billion in dividends and repurchased $4.2 billion in stock during Q2, alongside a $1.6 billion debt paydown. Although AVGO shares trade at a premium forward P/S ratio of 16.69X compared to the sector's 6.38X, its year-to-date performance of +5.2% has outpaced the industry and key peers, supported by upward revisions in consensus earnings estimates for fiscal 2025 and Q3 2025, projecting 36.14% and 35.48% year-over-year growth respectively.

Key Decisions for Investors

• Investors should assess Broadcom's robust AI-driven revenue growth, particularly from XPU and networking solutions for hyperscalers, against the near-term gross margin headwinds stemming from the XPU sales mix and sluggishness in non-AI segments.
• Consider the company's strong free cash flow generation, which supports substantial shareholder returns through dividends and buybacks, as a key factor mitigating some valuation concerns and underpinning financial stability.
• Monitor the evolution of gross margins throughout fiscal 2025 and the company's ability to offset XPU margin dilution with growth in higher-margin AI components or other business lines, particularly given the stock's current premium valuation.