Broadcom Poses More Earnings Downside than Up
Based on its earnings history and its track record of crushing analyst estimates, Broadcom (NASDAQ:BRCM) will beat the $0.75 Wall St. consensus EPS estimate on Thursday afternoon.
We’ll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.
On average, sell-side analysts on Wall Street expect Broadcom to report $0.75 in EPS for this quarter. Our model projects a 65-75% probability that BRCM will beat these projections. It expects a large beat on estimates, ranging from 5-10% higher than consensus (EPS between $0.79 to $0.83).
On average, sell-side analysts on Wall Street expect Broadcom to report revenues of $2.11 billion for this quarter. Our model projects a 65-75% probability that BRCM will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (revenue between $2.12B to $2.21B).
Analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. Analysts may do this to stimulate trading (e.g., Hayes 1998), to obtain access to management (e.g., Lim 2001) or to confirm a prior sentiment on a stock (e.g. Hwang 1996). In any case, analysts are incentivized to “play nice” with the companies that they cover, and this manifests itself in earnings estimates that are consistently lower than they should be.
This pattern of earnings estimate manipulation can be taken to the extreme in certain companies. Thus, an important factor to analyze when predicting whether a company will beat earnings estimates ahead of time is to look at its past track record of estimate beats. Broadcom appears to be an extreme example of earnings estimate manipulation as it almost never misses earnings estimates. Logically, you’d assume that analysts would simply revise their estimates higher (since they’re always too low) but for one reason or another, they don’t. Below is BRCM’s earnings history:
BRCM has only missed one EPS estimate in the last 10 quarters: FQ2 2013 when it missed by 2¢ on the Wall St. Consensus of $0.49 (4% miss). Since then, it hasn’t missed EPS and has beaten by an average of 15%. The trend in EPS beat size is clearly negative, as each of the last 3 beats have been smaller than the one prior. It should also be noted that over the last 24 quarters (6 years), BRCM has only missed on EPS twice, a remarkable consistency. A company’s recent EPS and revenue growth rates can also shine a light on growth trends in the company to see how analysts estimates compare to history. Below is BRCM’s EPS and revenue growth rates from the past 3 years.
The analyst consensus of $0.75 represents 63% Year-over-year (YoY) EPS growth from the $0.46 reported the same quarter a year ago. YoY EPS growth rose to 93.94% last quarter, and has been trending upwards ever since it was last negative FQ2 2012. Analysts are clearly expecting this EPS growth to slow down considerably to 63%, which seems overly pessimistic given the companies growth rate the past two quarters. Our estimate of $0.81 is more inline with BRCM’s current growth rates at 76%. Analysts appear to be continuing their trend of setting low expectations for BRCM.
From a revenue standpoint, analysts have been more inline with reported results, making revenue predictions based on past results less certain. Below is BRCM’s revenue history:
The strongest pattern from the past 12 quarters of revenue estimates is that analysts consistently set expectations too high for FQ2 and too low throughout the rest of the year. This pattern counters the basis for an upcoming revenue beat. The $2.11B that analysts are expecting this quarter would represent 3.38% YoY revenue growth from the $2.04B reported in FQ2 2014. This 3.38% would be inline with the recent slowing of BRCM’s revenue growth rate and is in line with our predicted revenue beats of 0-5%.
Another factor that plays a big role in our predictive model is the recent performance of BRCM’s stock price. We’ve found through extensive historical back testing that the market tends to anticipate strong earnings ahead of time, and thus stocks are bid up in price ahead of earnings. Below is a look at some of the inputs to our technical analysis model, that shows how BRCM’s current price compares to its recent moving averages:
BRCM is underperforming its short-term moving averages of 20 and 50 days, but outperforming the longer moving average of 200 days. These numbers are highly influenced by the 21% price surge that BRCM experienced on May 27th when it announced that it would be acquired by Avago for $37 billion (the largest ever merger between chip makers). The stock is slowly correcting from the high of $57.70 from that day, but remains 12.5% higher than it closed on May 26th. These earnings may be of reduced importance given that the buyout price has been agreed upon (shareholders can elect Avago stock (0.4378 shares) or $54.50 in cash), but nonetheless, given the adverse effects of unexpected EPS misses on BRCM’s share price (and the smaller, positive effects of EPS beats) traders can use this opportunity to take a short-term position on the stock.
Broadcom shares have a 1-day average price change on earnings of 5.78%. Options are pricing in an implied move of 5.34% off earnings. While an EPS beat is more likely, the downside from a miss will have a greater effect on the stock’s price. The average gain following an EPS beat over the last 12 quarters has been 3.3%, while the average drop from a miss is 15%. Over those same 12 quarters, BRCM’s stock price has dropped 4 times following an EPS and revenue beat. Both revenue misses over those 12 quarters resulted in a price drop.
While we expect the recent buyout announcement to reduce the importance of this quarter’s earnings announcement, there is still an opportunity for traders to profit given the historical volatility of this stock’s share price on earnings day. We anticipate a large EPS beat with confidence, but feel less certain about a revenue beat given the downward trend in the company’s revenue growth. If history is any indication, expect a downward revision should BRCM fail to beat the $2.11 billion revenue estimate, and an even bigger revision should the company miss the $0.75 EPS estimate.
It should also be noted that our data provider, Zack’s Investment Research, has given BRCM a Zack’s Rank of “1 - Strong Buy”, indicating their bullish short-term (1-3 month) sentiment towards the stock. Our own proprietary technical model is neutral on a short-term basis for BRCM, but is bullish on a 1-yr time horizon given the strength of the company’s earnings quality, expert sentiment, and its momentum. Read more here about our 1-yr predictions.
