Taiwan Semiconductor is critical in AI proliferation.
Taiwan Semiconductor (TSM -4.20%) may be the most important company in the world. It’s a contract chip manufacturer, and the incredible technology from Nvidia, AMD, or Apple wouldn’t be possible without its chip foundries. With the stock down around 10% from its all-time highs, is it time to capitalize on this discounted price and buy Taiwan Semi shares?
TSMC has best-in-class technology
Taiwan Semiconductor has long been the leader in chip production. Because of its neutral position as a manufacturer, it doesn’t matter which company has the best product — it will benefit from the general rising tide of more advanced technology being adopted.
TSMC is one of the few companies that can manufacture 3nm (nanometer) chips, which are the most powerful varieties available. The distance these chips are named after corresponds to the distance between traces on a chip. For comparison, a human hair is approximately 80,000 to 10,000 nanometers thick — this should give investors an idea of just how small these chips can be made.
As the distance between traces decreases, more logic or transistors can be packed onto a chip. This drives companies like Taiwan Semi to innovate and launch even more powerful chips.
The next generation of chips is already under development, with TSMC’s 2nm chip scheduled to reach production in 2025. Management is very excited about this technology as the pre-production demand for these chips is outpacing its 3nm and 5nm demand.
While its 2nm chips can be configured for greater processing power, the real improvement comes from energy efficiency. When configured for the same computing power, these chips are expected to consume 25% to 30% less power than previous-generation chips. Considering that power input is a massive cost for computing servers dedicated to artificial intelligence (AI) model training, it’s no mystery why these chips will be in high demand.
Because Taiwan Semiconductor works with nearly every company that needs chips, it’s slated to benefit massively over the next few years.
Expecting large growth in the next few years
While management doesn’t provide exact guidance for its fiscal years, it projects it can increase revenue at a 15% to 20% compound annual growth rate (CAGR) “over the next several years.” That’s massive sustained growth for a company of TSMC’s size, but it’s not hard to see how it could do that considering the massive demand for its chips.
This is largely due to the surge in demand for AI computing power. Management expects this segment to grow at a 50% CAGR through 2028, when it will make up more than 20% of its total revenue. That’s a big runway, but what would that do for its stock price?
Let’s say TSMC can achieve a 15% revenue CAGR from now until 2028 while maintaining its current profit margin of 38%. In four years, that would mean TSMC would produce $134 billion in revenue and $50.9 billion in profits.
Using Taiwan Semi’s decade-long average price-to-earnings (P/E) ratio of 20 as its base valuation case would mean the stock has a 14% upside from here.
TSM PE Ratio data by YCharts.
That’s not a very attractive investment, especially considering that it would take four years to return to that level. If we tweak the assumptions for TSMC’s revenue to grow at 20% and the ending P/E ratio to be at 24 (its five-year average), then that upside increases to 63%. This equates to a CAGR for the stock price of 13%, which would beat the market’s long-term average.
Still, TSMC would have to perform at the high end of its expectations to achieve that, which doesn’t leave much margin for error. But with massive growth slated ahead for TSMC, I still think this could be a buying opportunity for the stock. Investors must be aware of the high expectations baked into the current stock price, even if it is still down 10% from its all-time highs.
Keithen Drury has positions in Taiwan Semiconductor Manufacturing. The Motley Fool has positions in and recommends Advanced Micro Devices, Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
