taiwan semiconductor manufacturing (TSM -1.45%) is one of the most important companies in the world. The company’s manufacturing and technological capabilities are superior to its competitors, which is why it manufactures chips for almost every major technology company in the world. This is also why the US is so invested in maintaining the “two systems, one country” status quo in Taiwan, even though mainland China wants more control over the island.
The company has huge investment tailwinds behind it, as there is huge demand for chips, especially in the artificial intelligence (AI) field. But what will TSMC (as it’s commonly called) look like in three years? After all, what it does during that time will determine whether it’s a good investment or not.
Small chips are a big problem
One of the reasons Taiwan Semiconductor has established itself as a top leader in the chip industry is its culture of continuous improvement. Currently, TSMC is producing 3-nanometer chips. However, the company is also developing 2nm chips, which are expected to be ready in the second half of 2025 and ramp up to production in 2026. Additionally, the company is working on a 1.4nm chip, which is unlikely to be released within three years.
What Taiwan Semiconductor does over the next three years will have a lot to do with how its 2nm chips perform and how well the rest of its business continues to perform in an environment of booming AI revenue. Sho.
Back in Q2 2023, management boldly predicted that AI-related revenue would grow at a compound annual growth rate of 50% over the next five years until it reaches a low-teens percentage of revenue. I did. However, management significantly underestimated the demand for AI-related chips. With AI revenue currently growing three times year over year, we expect AI revenue to account for mid-teens of revenue by 2024.
This is a huge tailwind, and given that many of the largest cloud service providers (or hyperscalers) plan to increase spending on AI infrastructure in 2025, it could be of great benefit to TSMC in the near term. . And that 2 nm chip will be a huge improvement beyond that point.
Forecasting strong growth
One of the biggest costs of running these AI models is the energy consumed in data centers. One of the most popular graphics processing units (GPUs), Nvidia’s H100, consumes about the same amount of power as a typical American household uses in a year. Given that thousands of these GPUs are used together within a server, these devices can be very expensive to run.
But what if Nvidia could make it even more energy efficient?
TSMC’s 2nm chips promise just that, with executives saying these chips will consume 25% to 30% less power than 3nm chips when configured to run at the same speed. This is a significant cost reduction, and alone is enough for companies to upgrade their GPUs. TSMC already expects demand to exceed demand for 3nm and 5nm chips at this stage.
This could be a big revenue driver for the company, as the chip will reach full-scale production in 2026. This is well within our three-year time frame and TSMC will benefit greatly from this new technology.
So where will TSMC be in three years? I think it will be a much better place than it is now. Management expects 2024 revenue to rise about 30% year over year, and Wall Street analysts predict 25% growth in 2025. Introducing the growth lever of 2 nm chips in 2026 will create a company with a high potential for revenue growth. It will remain around 20% for a while. If that happens, further earnings growth will be encouraged, and Taiwanese Cicada’s valuation will fall.
TSM PE Ratio (Forward 1y) Data by YCharts
However, the stock is not trading at such a high valuation at the moment. TSMC’s 2025 P/E ratio is about 22 times, making it not the most expensive stock in the world, but not cheap either. But considering how important the company is to the chip industry, it’s a fair price to pay.
Taiwan Semiconductor’s earnings are expected to grow rapidly over the next few years, and I’m confident that it will not only outperform the stock market in terms of performance, but blow it away. Advances in technology and performance over the next three years should make this prediction a reality.
Keithen Drury works for Taiwan Semiconductor Manufacturing Company. The Motley Fool has a position in and recommends Nvidia and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
