Shares of tech giant Broadcom (AVGO 12.47%) were in a free fall on Thursday after the company posted its latest earnings numbers. The stock was down around 16% at one point in the morning.
What may seem puzzling is that the company, which has been experiencing a surge in demand due to artificial intelligence (AI), generated strong earnings, and its growth looked terrific in its most recent quarter. However, this sell-off serves as a cautionary tale for AI investors who believe that stocks will just continue rising higher and that valuations don't matter.
Image source: Getty Images.
On Wednesday, Broadcom reported its latest earnings numbers for the second quarter of Fiscal 2026. Its revenue totaled $22.19 billion for the period ending May 3, which was an impressive increase of 48% year over year. But that came in slightly below expectations of $22.27 billion. Its adjusted earnings per share of $2.44 did, however, come in higher than Wall Street projections of $2.40.
What seemed to have tipped the scales for the stock was that, despite the growing demand for the company's custom AI chips, management didn't raise the guidance for the current year. Meanwhile, it continues to expect its semiconductor revenue to exceed $100 billion next fiscal year.
While Broadcom's growth remains impressive and it still sees more opportunities ahead, without a beat-and-raise quarter, which tech investors may have become accustomed to, it resulted in a significant fall in the share price. Broadcom, after all, trades at around 100 times its trailing earnings, and that kind of a premium comes with high expectations. Falling short, as investors have seen with the stock today, comes at a high price.
The danger in tech these days is that investors are caring less and less about valuation, and that can lead to significant risk later on. While Broadcom's stock has declined significantly today, it can still fall much further, as is the case with many other high-priced stocks.
It's crucial to not only look at a company's growth prospects and financials, but also its valuation. A business may be doing exceptionally well, but that doesn't mean its stock is an automatic buy. If it's trading at a high premium, then you may be paying for a lot of future growth. That means expectations will be elevated for the company to not only do well, but to continue raising forecasts along the way.
Broadcom's decline serves as an important reminder of why valuation always matters and should never be ignored when investing, as investors who do so could leave themselves vulnerable to significant losses later on.
David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Broadcom. The Motley Fool has a disclosure policy.
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Shares of Broadcom crashed after the company reported earnings, even though the numbers were strong.