If you paid attention only to media headlines, it may seem like the market has shifted its tune decisively from "grow revenue at any cost" to "all that matters is the free cash flow."
While there is certainly some truth to that in the backdrop of high inflation and rising interest rates, the reality is for most businesses, the ability to generate and grow their free cash flow has always been foundational to their long-term success. And if they can accomplish that while growing revenue at a healthy rate, that's usually a recipe for success.
Two such businesses that deserve a close look from investors are Airbnb (ABNB 0.10%) and Broadcom (AVGO 2.99%). While no business is entirely immune to severe economic downturns, these two companies have proven their staying power and are likely to produce handsome returns in the long run.
Airbnb: A broad moat powering growth at scale
This travel disruptor, with its easy-to-use marketplace, has created an unmatched convenience for travelers to choose short-term rentals from a broad variety of accommodations and price points. Airbnb has become a top option for travelers, but that journey hasn't always been rosy. The pandemic posed a major existential threat to Airbnb as the world shut down.
But the company learned its lessons of fiscal discipline and has turned into a lean operator. Compared to 2019, Airbnb's employee headcount is 5% less, while its revenue has grown by 75%.
For 2022, the total value of nights and experiences booked on Airbnb's platform grew 35% year over year to $63 billion. For the same period, its revenue rose 40% to $8.4 billion. Airbnb was able to turn an impressive 40% of that revenue to free cash flow reaching $3.4 billion, a jump of 49% over the last year.
Airbnb used $1.5 billion of that cash to repurchase its stock, reducing the share count by 1.3% from the end of 2021 to the end of 2022. It still had a massive $9.6 billion in cash and equivalents at the end of 2022.
Image source: Getty Images.
Airbnb's highly scalable business model is the primary driver of its prolific cash generation. Unlike traditional hotels, Airbnb doesn't own, lease, maintain, or operate the properties available on its platform. That significantly reduces the upfront and ongoing capital expenditures and operating expenses for the company. Also, the addition of new hosts, listings, and customers for Airbnb comes at a negligible cost. In other words, the company can grow its revenue at a significantly faster rate than its costs.
Airbnb has created a global brand that continues to grow. Greater interest from customers is bringing more hosts and properties to the platform, creating a network effect. At the end of 2022, Airbnb had 6.6 million listings on its platform, 900,000 more than the beginning of 2022. For such a dominant business with a large opportunity in front of it, Airbnb's stock -- trading at about 25 times its price to free cash flow -- doesn't seem overpriced.
Broadcom: An under-the-radar compounder
Broadcom may not be a household name like Airbnb, but that likely won't hold investors back once they look at its stock's performance. Over the past five years, Broadcom has produced 139% returns for its investors (relative to the S&P 500's 49%), and since its initial public offering in 1998, it has generated an unbelievable 3,600% return (versus the S&P 500's 309%).
Broadcom has two main areas of business: semiconductor solutions and infrastructure software. The semiconductor business contributes about 76% of the revenue and focuses on providing essential components to modern enterprises to build their technology networking, broadband, server storage, and wireless solutions. Broadcom's infrastructure line offers products to businesses in the areas of cybersecurity and software engineering.
Consistent execution has been a key to Broadcom's success and that trend continued in its fiscal 2022 (ended Oct. 30). In 2022, revenue was up a robust 21% year over year to $33.2 billion, and its free cash flow rose 25% to $16.3 billion. That kind of business efficiency of converting about 50% of revenue to free cash flow is just unheard of today. Zooming out over the past four years -- from 2018 through 2022 -- Broadcom has expanded its revenue at a steady compound annual growth rate (CAGR) of 12.4%. For the same period, its free cash flow has grown at a CAGR of almost 19%. It's no wonder the company has outperformed the S&P 500 index handily.
The cash-rich model allows Broadcom to also offer a healthy dividend that's currently yielding 3.1% annually. Broadcom also bought back $8.5 billion of its shares in 2022 and plans to spend $13 billion in buybacks in 2023.
Broadcom has been a serial acquirer and is currently in the process of acquiring VMWare. The acquisition is going through a regulatory review and could be a catalyst for Broadcom's infrastructure software business. And in case the acquisition doesn't go through, it doesn't really hurt Broadcom. This is a high-upside, low-downside scenario for the company.
It is rumored that Apple -- Broadcom's largest customer responsible for 20% of its total revenue -- may start producing some or all of the chips it currently receives from Broadcom. While that could certainly be a blow to Broadcom's business, Broadcom's growing portfolio of products and customers should be able to replace that potential loss of revenue. For now, Broadcom sees steady overall demand for its business in 2023.
For such a stellar business, Broadcom is trading at a very reasonable multiple of 15 on a price-to-free-cash-flow basis. This proven performer is likely to continue its winning streak for a long time.
