This article is a continuation of our free newsletter from June 12, This AI Stock is Set to Surge from Inference Demand.
For our Premium Members, we discuss the following:
- The one thing Broadcom CEO stated that all investors MUST hear to help position for 2025-2026.
- The clear catalyst within Broadcom’s product portfolio and timing for this product to help push forward the next leg up in AI revenue growth.
- The I/O Fund’s trade setup and buy zones we are eyeing for Broadcom given its immense demand yet stretched valuation.
What Hock Tan Said that Every Investor Needs to Hear
There was a subtle yet important change in commentary this past quarter around Broadcom’s hyperscale customer deployment expectations.
- In Q4 FY25, two quarters ago, Broadcom stated that they expected each of their three current hyperscale customers to deploy 1 million XPUs across a single fabric by 2027.
- However, in Q2, this commentary shifted – management now said they “eventually expect at least three customers to each deploy 1 million AI accelerator clusters in 2027.”
This implies that one or more of their four prospective customers are also planning a significant accelerator deployment in short fashion, driving Broadcom’s total revenue opportunity higher.
There were additional hints the current estimates are too low, such as when Hock Tan stated: “Turning to XPUs or custom accelerators. We continue to make excellent progress on the multiyear journey of enabling our 3 customers and 4 prospects to deploy custom AI accelerators. As we had articulated over 6 months ago, we eventually expect at least 3 customers to each deploy 1 million AI accelerated clusters in 2027, largely for training their frontier models. And we forecast and continue to do so a significant percentage of these deployments to be custom XPUs. These partners are still unwavering in their plan to invest despite the certain economic environment.
In fact, what we've seen recently is that they are doubling down on inference in order to monetize their platforms. And reflecting this, we may actually see an acceleration of XPU demand into the back half of 2026 to meet urgent demand for inference on top of the demand we have indicated from training. And accordingly, we do anticipate now our fiscal 2025 growth rate of AI semiconductor revenue to sustain into fiscal 2026.”
This circles back to Q4 2024’s serviceable addressable market (SAM) forecast, when management laid out a 60% CAGR through 2027 to a $60 billion to $90 billion SAM, which AI growth is now tracking. That SAM forecast was based on its view for three hyperscalers deploying 1 million accelerator clusters, or ~$20 to $30 billion per hyperscaler. Prospective customers were not included but it was noted they could “significantly” expand the SAM should they transition to revenue-generating customers.
The subtle shift in deployment commentary hints that Broadcom’s SAM could expand to north of $100 billion on the high end should it be able to transition just one of its prospective customers to revenue-generating. With AI growth of 60% YoY this year and next tracking SAM growth, a possible SAM expansion and thus a higher SAM CAGR suggests AI revenue could remain stronger for longer, or expand above current forecasts as 2027 rolls around. Bank of America analysts seem to share this view, saying it is “only a matter of time” before the SAM forecast is raised, “especially as the FY27 sell-side AI revenue consensus estimate is still well below $45 billion.”
Tomahawk 6 Enabling Path to 1 Million Accelerator Clusters
Broadcom has been quite vocal about the industry’s path to 1-million-plus accelerator clusters, constantly reiterating how its three hyperscalers “each race towards 1 million XPU clusters by the end of 2027.” This would be multiples larger than current deployments, with xAI’s Colossus supercomputer recently expanding from 100K to 200K GPUs. Broadcom has continuously re-emphasized this forecast as it represents two major growth opportunities for the company: significant growth in accelerator deployments with inference tailwinds, and even more growth in networking deployments to support these clusters.
The shift to Ethernet and away from Nvidia’s lock-in ecosystem of GPU + InfiniBand is benefiting Broadcom, with the industry pointing to rising Ethernet demand. Arista said that momentum for Ethernet “has really shifted in the last year” while Nvidia touted that its new Spectrum-X Ethernet is annualizing at $8 billion in revenue, or $2 billion quarterly. Broadcom noted that AI networking revenue rose 170% YoY in Q2 as demand remained above expectations.
The company is committed to remaining on the leading edge of networking with its newest Tomahawk 6 switch, the industry’s first 102.4 Tbps Ethernet switch. The next-gen switch doubled the bandwidth of its predecessor, while offering flexible deployment ability with 1,024 100G or 512 200G SerDes options, reducing switch count.
This raw performance upgrade paves the way for >100K to 1 million accelerator clusters by allowing larger leaf-spine fabrics to be constructed, while drawing less power and keeping latency low. Broadcom exec Ram Velaga said that demand for the new switch is “unprecedented” with multiple >100K accelerator deployments “using Tomahawk 6 for both the scale-out and scale-up interconnect.”
When discussing Tomahawk 6, management points toward the flattening of the AI cluster as an important catalyst for this product, stating: “[…] Tomahawk 6 enables clusters of more than 100,000 AI accelerators to be deployed in just two tiers instead of three … this flattening of the AI cluster is huge because it enables much better performance in training next-generation frontier models through a lower latency, higher bandwidth and lower power.”
Additional commentary the CEO shared in terms of the AI networking opportunity was that the opportunity for scale up is 5-10X more than scale out – setting up a nice trajectory as AI clusters grow:
“In fact, the increased density in scale up is 5 to 10x more than in scale out. And that's the part that kind of pleasantly surprised us and which is why this past quarter, Q2, the AI networking portion continues at about 40% from what we reported a quarter ago for Q1. And at that time, I said I expect it to drop. It hasn't.”
Quick Note on Margins
The market loves this stock – and one of the primary reasons why is its earnings power.
Broadcom reported adjusted operating income of $9.8 billion, up 37% YoY, outpacing revenue growth by a factor of 1.8x. Adjusted operating margin was 65.3%, expanding more than 8 points YoY. Adjusted EBITDA surpassed $10 billion for the first time, for a 67% margin.
Margins are also rather strong in both of Broadcom’s segments: Semiconductor gross margin expanded 1.4 points YoY to 69%, while operating margin rose 2 points YoY to 57%. Infrastructure Software gross margin surged 5 points YoY to an astounding 93%, while excellent execution on integrating VMWare drove operating margin 16 points higher to 76%.
However, VMWare’s expensive price tag means Broadcom’s debt is elevated, at $67.8 billion in gross principal debt versus $9.5 billion in cash. Given the structure of Broadcom’s debt with a majority at a fixed 3.8% rate, annual debt payments are currently close to $2.7 billion.
Quick Note on VMWare Software:
VMWare helped drive outperformance in Infrastructure Software, with revenue growing 25% YoY to $6.6 billion in Q2, ahead of management’s expectations for $6.5 billion on successful conversion of enterprise customers from perpetual vSphere to full VMWare Cloud Foundation (VCF) software stack subscriptions. Broadcom noted that strong VCF momentum has led to double-digit ARR growth in core Infrastructure Software. However, for Q3, Broadcom guided for a deceleration to 16% YoY growth to $6.7 billion.
For a deeper dive on VMWare, read the analysis Broadcom: Networking/ASICs Giant and The Second Largest by AI Revenue.Broadcom: Networking/ASICs Giant and The Second Largest by AI Revenue.
Broadcom Trade Setup:
By Knox Ridley
Like many AI related tech stocks, Broadcom appears to be in a large-degree uptrend that is not finished. The pattern that this bull cycle is tacking is a diagonal pattern, which is a 5-wave pattern that is marked with strong swings in both directions.
Based on the historic price action, there are two scenarios that we are tracking, both suggest higher levels from here, after we see an immanent period of volatility.
- Blue – This scenario suggests that the 3rd wave within the larger diagonal pattern ended in December of 2024. This would mean that we are in the 4th wave correction, and that the bounce off the April lows is a bounce within this larger correction. If this is playing out, the next drop will take the shape of an aggressive, and direct 5-wave pattern that ultimately breaks through $161.50. The final targets for this drop will be $139.50 – $102. We would then turn higher for another bull cycle to new highs.
- Green – This scenario suggests that the larger 3rd wave is not complete. When AVGO tops, the retrace will take the shape of a messy and overlapping 3-wave pattern, which will hold over $161.50. We will then turn higher toward the $400s in the coming months. This swing higher will complete the larger 3rd wave, as we set up for the larger 4th wave correction into 2026.
We do believe that the broad market signals are suggesting a correction is immanent. Several warning signals are also flashing in AVGO’s chart. One of which can be seen in how the last swing to new all-time highs, just before their earnings report, was accompanied with decelerating volume and momentum. In other words, though the sellers have not stepped up, the number of buyers is fading the higher we go. This is a common pattern that we see just before reversals.
In conclusion, how AVGO corrects from here is key. If we see a 3-wave retrace that holds over $161.50, it is setting up a great buying opportunity for a move to new highs. On the other hand, if we see a 5-wave pattern develop that breaks through $161.50, we will patiently wait for lower prices, which most investors believe is impossible based on how relentless this stock continues to advance.
Conclusion
The shift from AI training to AI inference is becoming increasingly visible as Big Tech and model providers highlight strong growth in tokens and revenue. Broadcom has already benefited from both increasing compute and networking needs – but we think the surge in inference demand will disproportionately (and positively) flow to Broadcom’s top line and bottom line.
This is because custom silicon’s cost advantages and ability to drive lower inference serving costs at scale creates a strong value proposition for Big Tech. As more and larger clusters are deployed to serve exploding inference demand, there will be additional long-term tailwinds for networking for the Ethernet networking giant.
Broadcom’s FY26 visibility is improving with management expecting near 60% YoY AI revenue growth to continue, while SAM could potentially expand past $100 billion as customer engagements remain strong.
We have plans to add Broadcom to our portfolio – keep an eye on your trade alerts and join Knox in his weekly Thursday webinar at 4:30 p.m. EST for more information on buy levels.
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Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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