Up about 75% since the beginning of the year as of this writing, Taiwan Semiconductor Manufacturing (TSM 5.28%)or TSMC for short, has been doing well this year, benefiting from building out its AI infrastructure.
Given the stock’s strong performance this year, the question on many investors’ minds is whether it’s still a buy. Let’s take a look at why the stock is in a good position and the potential risks it faces.
Riding the AI infrastructure wave
TSMC is one of the world’s leading semiconductor contract manufacturers, producing chips for some of the world’s largest technology companies, including Apple and Nvidia. Chip manufacturing is a capital-intensive business that requires the construction of expensive foundries and requires high utilization rates to remain profitable. As a result, many of the world’s top semiconductor companies outsource chip manufacturing.
TSMC has built a wide moat in this business due to its size and technological advantages. TSMC’s strong revenue growth and gross margin expansion in recent quarters may lead to the assumption that this is an easy move and that all companies in this space are benefiting from the boom in artificial intelligence (AI) chips. No, but that’s not actually the case.
In fact, the company’s two main competitors are struggling. Intel’s third-party foundry business has been weak, with the company posting huge losses and seeing revenue decline last quarter. Meanwhile, Samsung’s foundry business is suffering from financial difficulties due to unstable yields and customer losses.
As a result, TSMC has gained a market share of over 60% in the semiconductor contract manufacturing field, giving it a dominant position. The company is the primary manufacturer of Nvidia’s graphics processing units (GPUs), which are in constant demand. As a result, Nvidia continues to expand its manufacturing footprint to meet customer demand.
Meanwhile, Apple is the company’s biggest customer, and the company is believed to have already reserved all of TSMC’s latest 2-nanometer (nm) technology for its next-generation chips. All this while TSMC is still powering up its new 3nm technology and starting to scale up with this technology. Even Intel uses TSMC’s 3nm technology rather than its own foundry’s technology.
TSMC’s strong position in the industry, customer success, and cutting-edge technology result in the company’s strong pricing power. Meanwhile, Morgan Stanley says it has already told customers it will raise prices in 2025. Wall Street analysts expect the company to raise prices for its AI semiconductors and chip-on-wafer-on-substrate products by as much as 10%.
TSMC’s pricing power and strong capacity utilization are already leading to improved gross margins, even though new technology initially reduces margins until profits increase. Gross margin increased 460 basis points to 57.8% last quarter. Two years ago, the company’s gross profit margin was just 43.4%, which shows that the company has made significant improvements in this area. On the other hand, the higher a company’s gross profit margin, the more likely that revenue will turn into profit.
Image source: Getty Images.
Risks to Taiwan Semiconductor’s business
Taiwan Semiconductor is currently firing on all cylinders, but inventory comes with risks.
The company is enjoying strong demand for its AI chips, resulting in increased production capacity. But if spending on AI infrastructure eventually slows, perhaps as AI models become good enough, profits could decline and stock prices could fall.
Foundries need high production capacity to be profitable, so if a facility isn’t operating near full capacity, not only will revenue be reduced, but margins and profits will also be reduced. Therefore, much of the company’s future success will depend on continued strong demand for semiconductor chips.
The company and many of its foundries are also located in Taiwan, a disputed territory that China claims as its own territory. This increases geopolitical risks, as does a new presidential administration in the United States. Before the election, President-elect Donald Trump criticized Taiwan for dominating the U.S. semiconductor industry and said Taiwan should pay for its own defense.
Are Taiwanese semiconductor stocks worth buying?
Although TSMC faces potential risks, it is one of the companies best positioned to benefit from the continued buildout of AI infrastructure and the accompanying upgrade cycles for smartphones and PCs. Building out AI infrastructure appears to be still in its infancy, with big tech companies building data centers and large-scale language models (LLMs) that require exponentially more computing power for training. Capital expenditure (Capex) budgets are increasing. As they move forward.
From a valuation perspective, the stock trades at a forward price-to-earnings ratio (P/E) of less than 21 times, based on analyst estimates for 2025, and a price-to-earnings ratio (PEG) of just above 1. 1 stocks are considered undervalued, but growth stocks often have much higher PEGs.
TSM PE Ratio (Forward 1y) Data by YCharts
All things considered, TSMC stock is a solid pick for investors at current levels, given its attractive valuation and growth opportunities still in front of us as spending on AI infrastructure continues to rise. I think it looks like this.
Jeffrey Seiler has no position in any stocks mentioned. The Motley Fool has positions in and recommends Apple, Intel, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends the following options: February 2025 $27 short call on Intel. The Motley Fool has a disclosure policy.
