Welcome to the Weekly Compounder Update. Each week, I look past the headlines to stress-test the investment thesis of the companies on the Arbalist Watchlist. My goal is to separate the noise from what matters to determine if our long-term edge is widening or eroding.
Theme of the Week: Good Is No Longer Good Enough
This week, Broadcom, Costco, and Oracle all delivered earnings that reinforced their long-term bullish narratives. Broadcom’s AI revenue is essentially doubling. Costco’s digital efforts are surging. Oracle’s backlog remains solid.
Despite reports that confirmed each of their respective theses, the stocks notably failed to rally or sold off.
Why It Matters: This is a valuation reality check. When a company reports a strong quarter and the stock falls, it tells us that much of the positive narrative was already priced in.
The market has been pricing backlogs and future promises as if they are realized earnings. The truth is, they are not. When valuations stretch this much, two risks emerge:
- Future returns are lowered. Even for compounders, the compounding yield is compressed when the starting price is elevated.
- Small disappointments are amplified. Even the smallest hiccup like a slight margin guide down for Broadcom, or the small, explainable down tick in membership retention for Costco becomes disastrous for the stock price.
We are in a market where “Good” is no longer enough to sustain some of these multiples.
Deeper Look At Broadcom (AVGO)
The Headline: Broadcom had an excellent quarter with revenue up 28% driven by AI revenue. However, the stock fell as much as 10% as of this writing as management warned of near-term margin pressure due to the mix of AI hardware sales.
Thesis Check: Broadcom remains among the premier picks and shovels plays of the AI race.
As peers are burning cash to build models, Broadcom is selling the infrastructure. They generated over $12 billion in EBITDA this quarter alone. This, despite more than doubling R&D over the past 2 years. They also continue to return cash to shareholders announcing a 10% dividend increase.
The Narrative: The story is intact. Broadcom has a $73 billion backlog for AI chips and networking over the next 18 months. It appears that Hock Tan is executing the VMware integration perfectly, now driving margins in that segment to 78%.
The hiccup that prompted the sell off may have been triggered by a comment on the call that gross margins would dip ~100 basis points sequentially. The reason being that lower-margin AI hardware may become a bigger piece of the revenue pie. But this is the danger of high multiple stocks. And so, today the market ignored the massive cash flow and instead is fixated on a slight margin mix shift.
The Verdict: 🟢 Thesis Intact / Watch for Entry.
Broadcom’s narrative is working, but the valuation is stretched. Broadcom is trading at nearly 40x forward earnings. For context, just two years ago, it traded at 14.5x. Paying a software-like multiple for a cyclical hardware business leaves little room for error. I am not an owner today, but if enough air comes out of the valuation, it could become a very interesting opportunity to add to a high-quality cash printer.
The Compounder Pulse
| Ticker | Status | The One Thing |
| COST | 🟢 Intact | Costco’s first quarter was steady as digital sales surged 20.5% and management reiterated 30-plus warehouse openings per year going forward. However, like Broadcom, the stock price is still elevated despite pulling back nearly 23% from its highs. As I wrote in my deep dive, Why Costco’s Stock Defies Valuation Logic, the business is the epitome of quality, but the stock is not cheap. |
| AZO | 🟢 Intact | AutoZone fell after missing first quarter EPS estimates due to a $98M non-cash LIFO charge. While typically accounting noise, this is one that could have probably been included in the valuation theme. But the compounding engine appears to be intact as sales grew 8.2%, domestic commercial sales accelerated to 14.5%, and they opened 53 net new stores. |
| GOOG | 🟢 Intact | Waymo hit 450,000 paid weekly rides. This effectively widened its lead over Tesla. Meanwhile, YouTube TV is launching “genre-based” bundles to reduce churn. Alphabet’s search and AI business are not the only stories within this tech giant. |
| DIS | 🟢 Watch | Disney is investing $1B in OpenAI to license characters for Sora. This is Bob Iger playing offense. By partnering with OpenAI and simultaneously suing infringers like Google, Disney is establishing a framework to control how its IP is used. This is made clear by rules like strict guardrails (no actor likenesses) to ensure they capture AI engagement wave while maintaining the integrity of the brand. |
| ISRG | 🟢 Intact | The FDA cleared da Vinci SP for hernia and gallbladder procedures. This expands the addressable market for their newest system, reinforcing the narrative that being a first mover with the largest install base is an advantage that strengthens Intuitive’s moat. |
| AMZN | 🟢 Intact | Amazon expanded same-day grocery delivery to 2,300 cities. This effectively commoditizes the delivery speed of rivals like Instacart and DoorDash, which forces them to compete on margins they just do not have. |
Final Thought
This week was a reminder that valuation still matters. Broadcom, Costco, AutoZone and Oracle are all stronger businesses today than they were last week. Their moats are intact or widening. But the market has pulled forward years of gains and the pullbacks are wakeup calls that good news is no longer enough to support perfect multiples.
When those two realities collide, the prudent move is to do nothing. And so, I remain vigilant. I will continue holding my core winners and monitoring Broadcom and Costco from the sidelines. Therefore, I am not deploying capital today. I will let the gravity of valuation do its work and wait for the price the risks to a greater extent.
P.S.
🗞️ Want to know where to go next? Checkout my newly launched Quality Compounder Hub which include my Watchlist.
📚 Check out relevant articles:
