Veteran investment commentator Mark Hulbert wrote an appropriately-timed commentary for MarketWatch on July 22 that discussed how Broadcom (NASDAQ:AVGO) stock and 24 others were most likely to crash.
Hulbert highlighted the contrarian market indicator “U.S. Crash Confidence Index,” created in 1984 by Robert Shiller, the Yale professor best known for the CAPE ratio (cyclically adjusted price-to-earnings ratio), which is like the P/E ratio, except that the CAPE adjusts earnings to account for inflation.
According to Hulbert, the U.S. Crash Confidence Index for institutional investors is at or near the highest level in the past 15 years. It’s at the second-highest for individual investors.
He finished by pointing out that if a stock’s outperformance of the S&P 500 over the trailing two years is 150 percentage points higher than the index, a 40% correction is almost a certainty.
Hulbert kindly included a list of 25 stocks that had outperformed the index by at least 200 percentage points in the trailing two years. Broadcom was on that list, outperforming the index by 208 percentage points.
Does that make Broadcom a Sell? No. But it might not be a Buy either. Here’s why.
Yes It’s a Sell
One of the things I do to check on investor sentiment regarding a stock is to look at its daily options history for the past three months. Specifically, I’m looking at two things: the Put/Call Open Interest (OI) ratio and Put/Call Volume (Vol) ratio.
The former tells me the number of total puts and call contracts that are open currently. The latter is a snapshot of a day’s trading. It tells you the sentiment on that day.
On July 25, the P/C OI ratio was 0.83, which means of the 2.85 million option contracts open, about 45% were puts and 55% were calls. That’s a bullish indicator — since traders buy call options when they expect a security’s price to go up.
On July 26, the P/C Vol ratio was 0.85, two basis points higher than the P/C OI. The options volume on that day was 188,289, less than the 30-day average volume of 221,574, so not a huge day. The highest daily volume over the past three months was July 18. It was 560,378, a little more than double the 30-day average. AVGO stock jumped about 3% that day.
Given the P/C OI ratio was much lower in early July (0.67 on July 3), the investor sentiment appears to be turning bearish, but it’s not a massive sell signal at this point. Give it a few more days correcting and it should turn that way.
Broadcom’s Still a Buy
The analysts love Broadcom as an AI play. It’s even thought to be taking away some of Nvidia’s (NASDAQ:NVDA) thunder with some future AI partnerships that should generate significant revenue and profits for the company. Business Insider reported recent comments from Citi analysts:
“From our conversations, it seems AVGO is catching up to NVDA as the top holding as AVGO has more AI customers joining (OpenAI and Bytedance) and accretion from VMware. We also believe there is some investor fatigue with NVDA.”
In mid-July, Barron’s reported comments from JPMorgan analyst Harlan Sur about Broadcom. The analyst has an Overweight rating on the stock with a $200 price target.
“We see accelerating AI fundamentals combined with improving fundamentals in non-AI semiconductor business driving strong earnings revenue/earnings growth,” Sur wrote.
Sur added that Broadcom believes it can generate $150 billion in cumulative AI revenue over the next five years. That’s a lot of growth from just one segment of its chip design business.
Of the 46 analysts that cover AVGO, 38 (83%) rate it a Buy, with a target price of $200, about 33% higher than where it’s currently trading.
The Winner Is…
CNBC’s Jim Cramer reminded his Mad Money viewers on July 24 that Broadcom, a wonderful business, won’t be able to avoid getting swept up in the rotation away from Mag 7 stocks. As a result, it’s going to get hammered.
Should you buy at current prices? I don’t think so.
As recently as mid-April, Broadcom stock traded around $120 — about 21% lower than where it’s currently trading. With bearish sentiment coming on, albeit slowly, I would wait to see if you can get a better entry point around the low $130s or even $120s.
One way to do that is to sell puts expiring in 27 days (Aug. 23) that are out of the money. As I look at EOD July 26 trading, I see that the Aug. 23 $130 put has the highest open interest out of any of the puts out of the money at 2,410.
Based on the $151.63 July 26 closing price, you would generate $60 in premium income (an annualized return of 5.3%). Should you be required to buy the 100 shares, your net price would be $129.40, right around the preferred entry point.
The only caveat: your losses are unlimited should the share price fall below $130 by expiration in 27 days.
Broadcom stock is a Hold.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.
