Broadcom's Top Competitive Advantages

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Broadcom (NASDAQ: AVGO) is an incredible company. Over the years, through both smart organic investments and a series of shrewd acquisitions, the company has delivered tremendous value to its shareholders. The stock has risen about 376% over the last five years -- a performance that's backed by a 1,410% increase in free cash flow.

Even more incredibly, the company is still reasonably priced, trading at about 13.6 times its trailing-12-month free cash flow. Oh, and Broadcom has an awesome capital return policy, pledging to give back half of the free cash flow that it generated in the prior year to stockholders in the form of a dividend. (As of this writing, shares offer a generous 3.51% dividend yield.)

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Broadcom wouldn't be able to achieve the results that it does without having a set of strong competitive advantages to keep its business growing and its profit margin high. Here, I'd like to go over three of the company's top competitive advantages.

1. Research and development might

Broadcom's massive scale and financial success allows it to invest heavily in building future products. Over the last 12 months, the company spent nearly $4 billion on research and development -- a figure that has continued to climb as it has both broadened its portfolio and invested further in the businesses that were already there to begin with.

Now, simply spending some large amount of money on research and development isn't enough to guarantee success. That money needs to be both targeted at the right projects and those projects need to be led by capable individuals to ensure proper product execution.

One way to check to see if a company's research and development spending is paying off is to look at its gross margin profile. Between the first quarter of its fiscal 2018 and the fourth quarter of that same year, the company's non-GAAP gross margin rose from 64.8% -- a figure that'd already be considered excellent in semiconductors -- to 68.4%.

In the first quarter of fiscal 2019, non-GAAP gross margin climbed to 71.4% -- something helped along by the addition of mainframe software maker CA Technologies (software margins tend to be higher than hardware ones), as well as a richer product mix within its semiconductor business.

What Broadcom's high gross margin tells us is that the company's research and development organization is putting out best-in-breed products with excellent cost structures.

2. Excellent management

Broadcom is an exceptionally well-run company. I think that a key part of Broadcom's success is that management is very focused on executing on its core strategy of acquiring, integrating, and developing best-in-breed technology franchises. The company doesn't waste shareholders' time or money by investing in areas where the chances of delivering a good financial return aren't very high.

With that being said, simply having a good strategy and sticking to it isn't enough -- that strategy needs to be properly implemented. What we've seen from Broadcom year in and year out is that the management team can consistently execute on that strategy. The company's pre-existing segments keep churning out great products and delivering solid results and it continues to successfully buy and integrate new businesses that fit in with its long-term ambitions.

Having a strong management team running Broadcom is an incredible asset and a clear competitive advantage.

3. Deep customer relationships

By virtue of its strategy of running best-in-breed businesses, Broadcom enjoys a tremendous amount of scale within its core operating segments. That scale fuels the company's revenue and its aforementioned research and development wherewithal, but it also means that Broadcom is deeply in tune with big-picture industry trends -- something that allows the company to accurately assess customer requirements and build targeted products to meet those needs.

For example, Broadcom has long been Apple's (NASDAQ: AAPL) go-to supplier for Wi-Fi and Bluetooth connectivity chips, as well as for other components like touch-screen controllers. Broadcom's position as the incumbent provider of such chips means that it's highly likely -- as long as the company keeps executing properly -- that it'll sell better versions of those chips to Apple for future products.

Moreover, the deep relationship between the two companies may make it easier for Broadcom to win Apple's orders for some of the new types of chips that it needs. As an example, when Apple decided to add wireless charging to its iPhones beginning with the iPhone 8 series of smartphones (as well as iPhone X), it tapped Broadcom for wireless charging chips.

Broadcom's position as a market leader across its businesses coupled with the customer relationships that are borne from that seems like a long-term competitive advantage.

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Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: short January 2020 $155 calls on Apple and long January 2020 $150 calls on Apple. The Motley Fool recommends Broadcom Ltd. The Motley Fool has a disclosure policy.