Broadcom Reports Wednesday. Its Profit Is Growing Nearly 4 Times as Fast as Its Revenue.

Broadcom (AVGO -0.18%) reports its fiscal third-quarter results after the close on Wednesday, Sept. 2. Heading into the report, the chip and software giant’s trailing-12-month revenue is up 32% to $75.5 billion, extraordinary at this scale.

But the bottom line is moving far faster. Net income over the same period climbed 127% to $29.3 billion — nearly four times the pace of revenue growth.

About 39 cents of every revenue dollar now lands as profit, up from about 23 cents a year earlier.

Broadcom’s disclosures show where that spread comes from, and what Wednesday can and can’t settle.

Is the profit growth overstated?

Part of the 127% is inherited. In the fiscal third quarter of 2024, Broadcom reported a rare $1.9 billion net loss under generally accepted accounting principles (GAAP). The cause was a one-time $4.5 billion noncash tax charge tied to an intellectual property transfer to the United States. That loss sits in the year-ago window and flatters the trailing growth rate.

Strip that charge out, and profit still grew about twice as fast as revenue.

The most recent quarter needed no such help. In the fiscal second quarter, which ended May 3, revenue rose 48% year over year to $22.2 billion while net income climbed 88% to $9.3 billion.

The trend is the stronger evidence, I think. Broadcom’s GAAP operating margin has expanded from about 39% of revenue in the year-ago quarter to 44% in this year’s fiscal first quarter to nearly 49% in fiscal Q2. That is almost 10 percentage points in a year.

Costs are barely moving

The spread comes from the expense lines. While fiscal Q2 revenue jumped 48%, total operating expenses rose about 6% year over year to $4.6 billion. Research and development spending grew 11%. Selling, general and administrative costs fell. And the noncash amortization from past deals (about $2 billion a quarter) didn’t grow at all. A charge that took more than 13% of revenue a year earlier now takes about 9%.

Both segments are contributing. Semiconductor operating income nearly doubled year over year in fiscal Q2, lifting its operating margin from 57% to about 62% on 79% revenue growth.

And infrastructure software (built around VMware) turned 9% revenue growth into 13% profit growth because its costs fell. Its operating margin now sits near 79%, up from about 76% a year earlier.

Notably, the extra profit isn’t coming from richer margins on each product sold.

In fact, custom artificial intelligence (AI) accelerators and networking brought in $10.8 billion in fiscal Q2, CEO Hock Tan said, up 143% year over year — nearly three-quarters of the chip segment’s revenue. On the June 3 earnings call, then-chief financial officer Kirsten Spears said consolidated gross margin should decline in fiscal Q3 as AI grows as a share of sales. That is a product-mix effect, she said, not a structural change in chip margins.

In short, the profit surge comes from selling much more without spending much more.

Wednesday will test the spread at $29.4 billion

“In Q3 we expect consolidated revenue growth to increase 84% year-over-year to $29.4 billion, with non-GAAP operating margin stable at 67% reflecting our strong operating leverage,” Spears said in the company’s June 3 earnings release.

Non-GAAP (adjusted) results strip out items like stock-based compensation and deal-related amortization. Even on that friendlier basis, the guide asks a lot: costs stay in check while revenue steps up by about $7 billion from the quarter just reported. Tan expects $16 billion of the quarter’s revenue to come from AI, up more than 200% year over year.

Wednesday can settle that much. Does the cost discipline hold at $29.4 billion?

Today’s Change

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However, one report can’t settle the longer arc. Gross margin pressure from the AI mix could eventually outrun the cost discipline. Expenses may not stay near $4.6 billion forever as its AI revenue keeps doubling. Those answers play out over years.

Meanwhile, at around $369 as of this writing, down about 25% from its 52-week high of $495, the stock trades at about 60 times earnings — arguably steep, even for growth this fast. But the earnings under that price aren’t standing still. Trailing earnings per share more than doubled in a year. If the spread between profit growth and revenue growth holds, that price-to-earnings ratio shrinks quickly.

Ultimately, the spread is disclosed line by line, it has widened for a year, and management’s guide calls for a stable non-GAAP operating margin. But at about 60 times earnings, it is also the thing shareholders are paying for. If costs start climbing alongside revenue, profit growth falls back toward revenue growth, and today’s price-to-earnings ratio gets hard to defend.

If I owned shares, I’d hold them through Wednesday’s report. But I wouldn’t buy at this price, and for now I’d call the stock a hold.