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Taiwan Semiconductor Stock Analysis: Investment Insights

Taiwan Semiconductor stock analysis

Investors have been trying to find the next potential leg higher in technology stocks. After leading the way in the better half of 2023 and so far into 2024, generative AI – and those stocks that allow it to grow – may be top of mind for portfolios in the coming quarters.

Leading the way in the global supply of chips and semiconductors, Taiwan Semiconductor Manufacturing Co. (NYSE: TSM) could quickly become one of the top choices for investors seeking exposure to this tech wave.

However, some perils lie ahead for this industry darling. Investors considering buying this stock should be aware of the presently increasing geopolitical risks and company-specific limitations, but don’t worry; the U.S. government and other key players in the sector play a big enough role in helping TSMC's future growth.

A few elite names are splashing in the semiconductor space, such as stocks like Nvidia Co. and Intel Co., which draw attention and trust due to their U.S. presence. However, valuations have become too rich for Wall Street to keep considering.

Goldman Sachs Group Inc. recently suggested that investors could benefit from rotating out of tech and seeking other areas with higher potential upside. However, the investment bank's advice only applied to U.S. names.

Because Nvidia – arguably the most significant player in generative AI – gets its chip components from TSMC stock, the chip maker is “too big to fail.” For this reason, markets may shrug off the rumors of a potential invasion in Taiwan coming from China, a scenario the U.S. government is avoiding either way.

Through the CHIPS and Science Act, government officials seek onshore factories to produce chips and semiconductors, keeping intellectual property within the nation. To do this, billions of dollars need to be granted to the most – and only the most – essential names so they get a seat at the domestic table.

Understanding the Market Position of TSMC 

Global Semiconductor Industry Overview 

After suffering from supply chain disruptions during the COVID-19 pandemic, TSMC stock declined from a high of $144 a share in 2022 down to $60.5 for a more than 55% retracement.

Now that the semiconductor industry has found its footing, outlooks for demand and production have also been trending higher. The main drivers are in the personal computer and communications equipment segments, including the Internet of Things (IoT) space.

The semiconductor industry pushed a combined sales value of $574 billion (as of 2022); sales for TSMC were $70.4 billion over the past year, making up roughly 12% of the industry’s annual sales.

Most of the industry’s sales, about 48%, went to the U.S. markets, with Korea being in second place at 19%. This is important for investors since, as of 2022, up to 64% of net TSMC sales came from U.S. markets alone.

The U.S. government cannot afford to run the risk of a Chinese invasion right now, as a second wave of disruptions in semiconductor supply chains would have a severe economic impact on an already shaky economy.

Even though the nightmare conditions for suppliers during the COVID-19 pandemic are over, some side effects are still felt today. According to the February ISM manufacturing PMI index report, the computer & electronic products industry expressed semiconductors remain an issue in production.

In addition, the “Commodities in short supply” segment of the PMI included semiconductors. Now considered a commodity, investors can follow the component's performance through the VanEck Semiconductor ETF (NASDAQ: SMH).

This ETF outperformed the broader S&P 500 by almost 50% over the past 12 months, leaving the NASDAQ 100 behind by 35%. Despite being filled with technology names that brought it to all-time highs, not even the NASDAQ could keep up with pure semiconductor plays.

At a 20% weighting, Nvidia is the top holding in this ETF, with TSMC stock coming in second at 12.6%. Despite being responsible for Nvidia’s growth, TSMC stock still underperformed its customers by 143% during the past year, leaving the following TSMC earnings reports as a critical catalyst to have it catch up to the pack.

TSMC’s Competitive Edge and Challenges 

Apple Computer is another consumer tech giant that relies on Taiwan Semiconductor Manufacturing Company for its chip components. Knowing that Apple supports the domestic consumer and employs thousands of workers onshore, the government may be short-sighted in not investing in TSMC.

For this reason, the U.S. government has granted TSMC up to $11 billion, a decision that was made potentially due to TSMC’s competitive advantages over other prospects. Securing the U.S. markets and its two major customers sets the semiconductor industry away from most of today’s perceived risks.

Using the latest lithography technology, TSMC’s manufacturing processes allow the company to serve all these fast-growing markets. Most of today’s chips require less than 10 nanometers to make. Otherwise, their applications in AI and other markets wouldn’t be feasible.

Companies like Samsung and Nvidia haven’t been able to break through this lithography yet, making TSMC indispensable for the global supply of chips and semiconductors.

However, it isn't all sunshine and rainbows, as current supply chain issues still force TSMC to keep its margins and pricing power artificially low. Size really does matter in this case, as the company can afford to pay for additional shipping and freight costs.

Financial Performance Review of TSMC 

Recent Earnings Overview 

TSMC’s financial performance may have thrown investors off in the fourth quarter of 2023. With an annual sales decline (in USD terms) of 1.5%, the stock still rallied by 59% since the announcement. Market sentiment remains bullish due to recovering momentum.

Revenues jumped by 13.6% quarter-to-quarter as recovery trends rose in the smartphone and personal computer markets. Still dealing with supply chain constraints, as the Panama Canal and others remain bottlenecked, TSMC managed to keep its gross margins above 50%.

Gross margins stood at 62.2% a year ago, reflecting these companies' increasingly tricky situations when fulfilling demand trends. Net income margins remain industry-leading, at 38.6%, compared to Samsung’s dismal 5%.

More importantly, and the reason many would keep this stock in their portfolio, TSMC’s return on invested capital (ROIC) remains above 13%. Annual stock price performance tends to match the long-term ROIC rate, allowing shareholders to compound their wealth at this rate.

Investment in Research and Development 

Companies that rely on manufacturing of any kind face the same issue. Sleepless nights haunt management with one key concern: properly investing in research and development (R&D) to secure leadership positioning.

In the past quarter, TSMC's R&D spending made up about 8% of net revenues from 7% a year ago. The five-year trend shows that TSMC remains within the 7-8% mark for R&D. As revenues advance, more R&D spending may guarantee the company's global leadership positioning.

One caveat to these rates is that if investors notice a sudden jump in R&D spending (as a percentage of revenue), it could mean that management is fighting an unexpected competitor rising against the company’s competitive advantage.

In addition, the company opened its global R&D center in Hsinchu to further develop manufacturing processes centered around the newest technology trends while maintaining efficiency.

TSMC Stock Analysis: Trends and Forecasts 

Stock Performance Trends 

Over the past year, the stock's trends have reflected TSMC's financial performance. A stellar 65% performance left the semiconductor industry behind by as much as 46%.

On a long enough timeframe, investors will notice how the Federal Reserve’s interest rate direction tends to make the stock move, with the latest example being the 2020-2024 trend. In 2020, the stock nearly tripled on the back of interest rate cuts, then halved when the Fed hiked rates again, showing a repeating trend today.

With up to 3 potential rate cuts coming this year, markets bid up the price of TSMC stock again. This time, it could keep pushing higher as financial margins recover from easing supply chains.

Investors can also measure TSMC's stock performance against Apple and Nvidia. Historically (over the past decade), these pairs' prices have remained relatively close, meaning that when one moves, the other tends to follow.

Falling behind both Apple and Nvidia in the past year, fundamental economic laws, backed by a high correlation over history, call for TSMC stock to catch up to its customers in the coming quarters.

The last time TSMC stock deviated this far from Apple stock was in October 2022, when TSMC promptly rallied from $60 a share up to $108; that’s an 80% jump! History may not repeat itself, but it may rhyme as the difference between the two stocks is at a historical high again.

Future Growth Prospects and Analysts’ Forecasts 

While revenue guidance for the next quarter is at the lower end of the previous quarter, margins at TSMC could be set to improve.

According to management guidance, gross margins are set to advance by 0.5%, with the same projected improvement applying to operating margins. Wall Street analyst projections for earnings per share (EPS) back up the number set by insiders.

Looking to grow by 24% in the next 12 months, TSMC’s EPS remains superior to Nvidia’s 13% projection. Despite potentially increasing at nearly twice the rate as its customer, TSMC stock trades at a 28.3x P/E ratio, making it 60% cheaper than Nvidia’s 72.5x valuation.

The main drivers remain the same, and as global GDP expands, technology investments will likely follow along at all levels. From governments to businesses, all the way down to consumers, the consumption of electronics and even electric vehicles (EVs) will create a market that TSMC can keep serving.

All these factors go without saying, though generative A.I. is the segment all investors look up to. New breakthroughs in high-performance computing and data centers could be underrated in today's growth projections for TSMC.

Investment Insights on TSMC Stock 

Evaluating the Investment Potential 

A consensus price target of $180 set by Susquehanna Bancshares analysts calls for up to 23% upside from today’s TSMC stock price. With the prospect of an unexpected recovery in the semiconductor supply chain, these valuations may be on the spectrum's conservative side.

Being the market leader also gives TSMC an advantage, as new competitors are easily blocked away through tightly patented intellectual property. The company operates on only 22% of its capitalization's total debt, giving management enough flexibility to respond to unforeseen shifts in the market.

Adding to that flexibility, the company's cash and cash equivalents in the fourth quarter of 2023 were $47.6 billion. Free cash flow (operating cash flow minus capital expenditures) stood at roughly $9 billion in the last quarter, giving it further breathing room to sustain artificially low margins until supply chain environments return to the past norm.

Risks and Opportunities 

The gist of owning TSMC stock is a two-way street. On one side, investors have the total weight of the U.S. government initiative to onshore semiconductor manufacturing. This goal called upon TSMC to fulfill its mission.

Conversely, the risk lies in the shift from Asian manufacturing to American manufacturing, which won't happen in time. Because China readily expresses interest in claiming Taiwan back, the clock is ticking for the chipmaker to move its logistical network into American soil as soon as possible.

Following Moore's law, which expects technological capabilities to double every two years, TSMC needs to keep hiring – and retaining – top engineering talent. The good news for investors is that management is well aware of this, as the new global R&D center and historical budgets show.

As long as Apple and Nvidia stay and expand their financials and customer bases, TSMC may be safe for now, provided it can promptly eliminate geopolitical and intellectual property risks.

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