Analysis indicates that Broadcom’s increasing TPU mix is compressing gross margins without negatively impacting overall profitability.
The shift toward custom AI silicon is compressing Broadcom’s gross margin even as its operating margin expands—a divergence that forms the core investment thesis for the stock. Broadcom (AVGO) currently trades at $368.79, significantly below its 52-week high of $480.81. The shares have declined 17.3% over the past three months but remain up 23.7% year-over-year. The primary concern weighing on the valuation originates internally: the custom AI silicon fueling Broadcom’s growth carries thinner margins than its broader product portfolio. However, gross margin alone does not capture the full picture.
In fiscal Q2 2026, gross margin contracted by 32 basis points year-over-year to 77.1% on a non-GAAP basis, driven by a heavier weighting of semiconductor revenue. Management expects this compression to continue, guiding consolidated gross margin to approximately 74% for fiscal Q3 2026. Conversely, operating performance strengthened: operating margin expanded by 200 basis points year-over-year to a record high, with guidance pointing to stability at roughly 67% for the upcoming quarter.
These custom accelerators reside within Broadcom’s fastest-growing segment. AI semiconductor revenue surged 143% year-over-year to $10.8 billion in fiscal Q2 2026, accounting for nearly half of the company’s $22.2 billion in total revenue. While management acknowledges that its ASICs and TPUs carry lower margins than other products, the volume gains more than compensate below the operating line. The CFO attributed the 200-basis-point expansion in operating margin to operating expenses remaining largely flat despite the revenue surge.
Total operating expenses came in at $2.2 billion—slightly under 10% of revenue—with $1.6 billion allocated to research and development. This R&D pipeline directly funds the TPUs, Meta’s MTIA custom chips, and the AI networking silicon required to cluster them together. Consequently, the semiconductor division’s standalone operating margin climbed 460 basis points year-over-year to 62%. Such durable margin expansion is characteristic of the companies comprising the Trefis High Quality Portfolio.
This dynamic does not eliminate risk entirely. Broadcom’s AI business relies on six core customers, and management anticipates that at least one will diversify its AI compute sourcing across multiple vendors. This introduces revenue concentration risk, though not necessarily margin risk. Additionally, the stock is not inexpensive, trading at approximately 23 times trailing sales compared to a ten-year ceiling near 26x. The September earnings report will address a narrower set of variables: since both gross and operating margins are already guided (to ~74% and ~67%, respectively), the market’s sole focus will be whether actual operating performance aligns with management’s guidance.
Market expectations for price movement around the report are subdued. Implied volatility stands at 41, placing it in the 13th percentile of its own trailing annual range and notably low relative to broader market options pricing.
While this operating leverage model remains highly effective, Broadcom’s stock remains vulnerable to decisions made within a single client’s boardroom—a concentration risk that cannot be diversified away in a single-name position. The Trefis High Quality Portfolio addresses this by treating compounding as a systematic, rules-based allocation across a diversified basket of businesses rather than a concentrated wager. Historically, this approach has outperformed the S&P 500, S&P Mid-cap, and Russell 2000 indices.
> https://www.trefis.com/data/v2/rankings/FetchArticleSourceCheck?gf=Article_SurprisingBuy&stock=AVGO&gen=20260829&src=agent -->
Where The Buying Ran Strongest: 14 Large Cap Stocks At 52-Week Highs
Market Movers | Winners: CYPH, FWDI, GENB | Losers: RGNX, AIAI, TMS
The Premium On WMT Stock Vs What Its Peers Deliver
Who’s Most Likely to Put Daktronics on the Acquisition Scoreboard?
Get Paid 10.0% To Cap Your BKNG Stock At 15% Higher
Reading Between The Lines Of ADI’s Latest Call
$2.5 Billion In Payouts, A Lagging Stock: The CLF Trade-Off
History Has An Opinion On This SNPS Price Level