Important points
- Shares of chip design company Broadcom fell on Friday as Wall Street focused on the squeeze on margins from the company's fast-growing AI business.
- Investors have been scrutinizing tech companies' earnings more intensely in recent months as Silicon Valley worries about overspending on AI.
Broadcom's custom AI chip business is growing rapidly. But Wall Street is wary of how much upside this growth suggests.
Broadcom (AVGO) on Thursday predicted that AI-related revenue will double to $8.2 billion this quarter from a year ago. This is an acceleration from the most recent quarter, which was up 74% to $6.5 billion. But that forecast came with a caveat, which weighed on the stock price today. The stock recently fell about 10% in intraday trading.
Broadcom Chief Financial Officer Kirsten Spears said on a conference call with analysts Thursday night that she expects gross margins to contract 100 basis points (1 percentage point) from the previous quarter, “primarily reflecting a higher share of AI revenue.”
Important points
Optimism about artificial intelligence has driven tech stocks and the broader market to record highs this year. But growing concerns about an AI bubble have made investors more cautious in recent months, putting pressure on the stock prices of AI darlings in the process.
The idea that AI sales growth could weigh on profitability wasn't what investors wanted to hear. But investors have recently increased their scrutiny of tech companies' earnings due to concerns about soaring stock prices and unsustainable infrastructure spending, meaning even good news is coming under scrutiny.
As a result, the market's reaction to corporate performance was not so calm. Nvidia (NVDA), a major AI chip supplier and Broadcom's biggest competitor, beat earnings estimates last month, but its stock price fell under the weight of AI bubble concerns. Software giant Oracle (ORCL) said Wednesday that its backlog now exceeds $500 billion, but failed to convince investors that its massive AI investment will pay off quickly. The company's stock price fell yesterday, led by AI selling.
Meanwhile, Broadcom isn't the only tech company whose profitability is being squeezed by AI. In October, Oracle predicted gross margins for its AI cloud infrastructure business would reach 30% to 40%, about half that of its traditional software business.
This year's AI-driven rally has also set a high bar for profits for tech companies. Heading into Thursday's earnings report, Broadcom stock had risen 75% since the beginning of the year. Thanks to Google's latest AI models, the stock has risen about 20% in the last month alone. The AI model was trained on a chip designed by Broadcom and was hailed as a serious challenger to OpenAI's ChatGPT.
Bank of America analysts said in a note Friday that Wall Street's concerns about profitability are “reasonable concerns.” They lowered their margin forecasts for 2026 and 2027 by several percentage points. Nevertheless, both companies raised their profit forecasts for the year, reflecting the belief that faster revenue growth will more than offset the shrinking margins. Analysts at Deutsche Bank made a similar adjustment, raising their price target.
