You can’t go five minutes without hearing something Nvidia recently. The computer chip giant recently became the largest company in the world by market capitalization and is today valued at over $3.34 trillion. Investors are betting that the massive capital expenditure on artificial intelligence (AI) will continue, with Nvidia maintaining its dominant market position.
But which companies are the driving force behind Nvidia? There is one that stands above all others and is the backbone of the most advanced semiconductor manufacturing in the world. Enter Taiwanese semiconductor manufacturing (NYSE: TSM)a company powering Nvidia and the AI revolution.
Is the stock a buy? Let’s take a closer look and find out.
Taiwan Semiconductor: The Backbone of Modern Computing
Taiwan Semiconductor (TSMC for short) has risen above the competition in chip manufacturing thanks to its innovative foundry model. What this means is that TSMC doesn’t sell the chips it makes directly to customers — Intel‘s old business model – but collects orders from computer chip designers. This allows it to focus solely on manufacturing expertise and maintain an edge in the most advanced semiconductor manufacturing in the world.
It has few if any competitors like Intel, Samsung, and homegrown Chinese players. Customers include: Apple, Alphabet, Amazon, and the aforementioned Nvidia. With the increasing demand for new AI tools, companies are forced to purchase chips from players like Nvidia or design their own chips. They outsource almost all of this production to TSMC.
With minimal competition and huge switching costs, the company has tremendous customer loyalty and great pricing power that allows it to generate outsized profits. In the last 1 year, operating revenues have grown almost 300% and in the last 12 months they reached $30 billion. It generates just over $70 billion in revenue and saw 30% revenue growth in May as more orders came in due to the AI investment boom.
Investors are betting on AI and geographic diversification
TSMC stock is up 439% over the past five years and has hit multiple all-time highs in 2024. Investors are betting that the AI revolution will continue to drive company growth in the coming years. Still, anyone looking to buy stocks today should wonder whether the market is getting a little over-enthusiastic about AI companies at the moment.
Some may see parallels to the dot-com bubble with AI stocks. Although the Internet has become one of the most important technologies ever, this did not prevent overpriced stocks from falling 90% when the bubble burst. Given its diversification across the entire semiconductor market, it’s hard to see a 90% pullback for TSMC, but the risk of an AI bubble remains nonetheless.
Another potential tailwind for TSMC is geographic diversification. The company is concentrating its production on its home territory, where the risk of Chinese aggression is increasing. Obviously this would be bad for shareholders.
To reduce this risk, TSMC is working with countries such as the United States to build factories outside Taiwan. It recently received $6.6 billion from the US government and is building factories worth tens of billions of dollars in the country. This will help reduce the risk of a Chinese invasion and boost growth over the next decade.
TSM PE ratio data according to YCharts.
But is the stock cheap?
Less than two years ago, TSMC was trading at a price-to-earnings (P/E) ratio just above 10. Now the ratio is about to exceed 35. In retrospect, TSMC was clearly undervalued at a bottom-line P/E. teenagers.
It’s hard to make the same argument as stocks soar to record highs. This isn’t a hyper-growth company that can immediately triple its revenue. Yes, revenue is currently growing thanks to AI spending, but that also comes with the bubble risk of new technologies. Let’s not forget the Chinese risk either.
The S&P500 is trading at a price/earnings of around 28. TSMC is well above this level, and it’s not like the market is cheap either. Taking all these factors into account, TSMC stock doesn’t seem like a good stock to buy at these prices, even though it is the backbone of the AI revolution.
Should You Invest $1,000 in Semiconductor Manufacturing in Taiwan Now?
Consider the following before buying shares in Taiwan Semiconductor Manufacturing:
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Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Brett Schafer has positions in Alphabet and Amazon. The Motley Fool holds positions in and recommends Alphabet, Amazon, Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 calls to Intel and short August 2024 $35 calls to Intel. The Motley Fool has a disclosure policy.
1 Unstoppable Stock Powering Nvidia and the AI Revolution was originally published by The Motley Fool
