No company has been a bigger winner than Nvidia (NASDAQ: NVDA) as nearly every tech company has collectively poured billions of dollars into developing their generative AI (artificial intelligence) capabilities. The company has added $2.5 trillion to its market cap over the past two years as sales and profits have exploded along with demand for its GPUs.
The chipmaker has shown incredible pricing power amid strong demand, with gross margins expanding into the upper 70% range. And with its booming revenue growth, it’s seen very high operating leverage, which has translated into massive net income growth. It’s certainly true that Nvidia’s performance as a company, not just a stock, has been nothing short of phenomenal over the past two years.
But Nvidia isn’t the only AI chip stock on the market. And CEO Jensen Huang just explained why another company might be worth owning, perhaps even more than his own.
“The best in the world by an incredible margin”
At an investor conference earlier this month, Huang spoke highly of one of Nvidia’s largest business partners: Taiwanese semiconductor production (NYSE:TSM)known as TSMC.
TSMC is the largest semiconductor foundry, or fab, in the world. When a company like Nvidia designs a new chip, it goes to TSMC to actually print the design onto a silicon wafer. That requires incredible precision and innovative engineering capabilities. TSMC is the go-to choice for many chip designers, including Nvidia. TSMC accounts for more than 60% of global spending on chip foundries.
“We manufacture from TSMC because it’s the best in the world,” Huang said. “And it’s the best in the world, not by a small margin, it’s the best in the world by an incredible margin.”
That’s why Nvidia and almost everyone else who needs to produce cutting-edge chips chooses TSMC over its competitors. Huang did say that Nvidia could switch to another foundry if necessary. But he also said that competitors’ capabilities don’t match TSMC’s and that would result in lower performance or higher costs.
He also praised TSMC’s ability to scale its business. When Nvidia saw demand for its chips skyrocket, TSMC was able to help it meet that growing demand, allowing it to capitalize on the opportunity. Any company that needs to scale should work with TSMC.
Importantly, TSMC’s position as a market leader, capturing the majority of revenue in the industry, ensures that it will maintain its leading position. It has more money to reinvest in R&D and create next-generation processes. The virtuous circle will lead to more and more large contracts with large technology companies designing super high-end chips over time.
TSMC still has a lot of growth to go
TSMC may be the largest company in the sector, but the company still has a lot of growth to achieve.
Tech companies are all planning to ramp up their spending on AI systems in data centers. Total spending on AI chip content and related systems is expected to reach $193.3 billion in 2027, according to IDC estimates. That’s up from $117.5 billion this year, representing a compound annual growth rate of 18% over the next three years.
Importantly, TSMC is highly agnostic about that growth. Whether that growth comes from Nvidia, one of its competitors, or from custom chips designed by its largest customers, TSMC is likely to win the bulk of those contracts. In fact, the virtuous cycle and TSMC’s leadership in advanced chips mean that it could grow that part of its business even faster than the industry. Plus, TSMC has room to improve its margins.
All of this is reflected in analyst forecasts for the company over the next five years. The average analyst expects TSMC to grow earnings by more than 20% per year over the next five years. But you don’t have to pay for that growth. Shares currently trade at just over 20 times the consensus 2025 earnings forecast.
Few other companies offer the same level of potential growth at that price. So not only is it the best fab in the world with an incredible margin, investors can now buy a stake in it for an incredible price.
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Adam Levy has positions in Taiwan Semiconductor Manufacturing. The Motley Fool has positions in and recommends Nvidia and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
Nvidia’s CEO Just Explained Why This Is The AI Chip Stock You Need To Own Originally published by The Motley Fool
