It’s the world of TSMC; the rest of us just live in it. 2024 will be a positive year for it Taiwanese semiconductor manufacturing (NYSE: TSM)the leading manufacturer of advanced semiconductors worldwide.
The company has embarked on a major expansion beyond its home market of Taiwan due to geopolitical concerns about China, prompting it to invest billions in factories in Arizona. Last week, the company announced a major milestone with these new factories in the United States.
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Here’s why TSMC’s latest update is important for the company’s future and what it could mean for the stock in the long run.
TSMC’s Arizona plant is being readied for commercial production in 2025. As the plant expands, the company is testing the yield of the semiconductor wafers pumped out by the manufacturing process. These wafers then become advanced computer chips, making them vital to companies such as Apple or Nvidia and the artificial intelligence (AI) revolution. The higher the yield, the more of each wafer contributes to the production process. Essentially it is a measure of how much of each wafer is working correctly.
Last week, TSMC reported that it achieved 4% higher yields at its Arizona factory compared to its factories in Taiwan. This is big news for the company. Why? Investors and analysts doubted whether TSMC’s factories would be as successful outside Taiwan, which has been the beating heart of the semiconductor market for centuries. Manufacturing advanced semiconductors is no easy feat, requiring teams of scientists, engineers, advanced technologies and institutional knowledge built up over decades.
Now TSMC has allayed fears that this process cannot be replicated in the United States. Higher yields mean that TSMC can sell more semiconductors per unit of production, while keeping costs the same. In other words, it should lead to higher profits, all else being equal. If TSMC were unable to replicate Taiwanese rates in Arizona, there was a risk that profit margins would drop significantly as all these new facilities came online. These fears are now being undermined.
These Arizona facilities – along with others in Japan and Europe – will be important to the AI market over the next five to ten years. TSMC may be the only company currently capable of building the world’s most advanced semiconductors for companies like Nvidia, the key supplier for all data center spending related to the AI boom.
In simpler terms, as AI spend grows, so does TSMC’s revenue. All these new factories should help the company keep up with customer demand, which seems insatiable. For example, TSMC’s high-performance compute (HPC) segment grew 11% quarter-over-quarter last quarter and now accounts for 51% of total revenue. Just two years ago, in the same quarter, the HPC segment represented only 39% of total revenue. HPC is spending money on advanced semiconductors for data centers, or AI.
Investors should keep a close eye on the HPC segment as it now makes up the majority of TSMC’s consolidated revenue and is growing like wildfire. If data center and AI spending continues to rise, TSMC’s revenues will likely continue to grow rapidly. With wafer revenues close to the same level as in Taiwan, profit margins should also remain high. Last quarter, operating margin was a robust 47.5%, demonstrating just how valuable TSMC’s advanced computing products have become.
With these booming sales and profits, TSMC’s stock is starting to rise. In the past year alone, the shares have risen more than 100% and briefly traded at a market cap of more than $1 trillion.
These gains have taken the stock’s price-to-earnings (P/E) ratio to 31, which is a premium valuation and slightly higher than the S&P500 index average. Some investors may be turned away from TSMC stock due to its high price-to-earnings ratio. However, I think this misses the forest for the trees. Yes, TSMC has a high price-to-earnings ratio, but it has proven over the long term that it can grow earnings quickly and has a big tailwind in the form of AI spending. Over the past decade, the company’s earnings per share (EPS) have grown by almost 300% cumulatively.
Despite this high valuation, I think TSMC stock is a buy at these prices if you believe in AI over the long term. One of the best companies in the world continues to expand its lead and is now showing that it can replicate its manufacturing process in other regions.
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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
Big news for investors in this artificial intelligence (AI) stock was originally published by The Motley Fool
