The company has given a big green light to its geographic expansion plans.
It’s the world of TSMC. The rest of us are just living in it. 2024 is turning into a positive year for Taiwan Semiconductor Manufacturing (TSM 1.26%)is a leading manufacturer of advanced semiconductors worldwide.
Geopolitical concerns with China have led the company to embark on a major expansion into markets outside its home base of Taiwan, investing billions of dollars in a factory in Arizona. Last week, the company announced important milestones for these new U.S. factories.
Here, we explain why TSMC’s latest update is important for its future business and what it means for the stock price in the long term.
Chip yield and why it matters
TSMC’s factory in Arizona is preparing for commercial production in 2025. As the company expands its facilities, it is testing the yield of semiconductor wafers sent through the manufacturing process. These wafers will become advanced computer chips, essential to companies like Apple and Nvidia and the artificial intelligence (AI) revolution. The higher the yield, the more of each wafer is used in the manufacturing process. Essentially, this is a measure of how well each wafer is performing.
TSMC reported last week that it achieved a 4% higher yield at its Arizona facility compared to its Taiwanese facility. This is big news for the company. why? Investors and analysts doubted whether TSMC’s factories would be as successful outside Taiwan, which has long been the center of the semiconductor market. Manufacturing advanced semiconductors is no easy task, requiring teams of scientists and engineers, advanced technology, and decades of organizational know-how.
Now, TSMC has alleviated concerns that the process cannot be replicated in the United States. Higher yields mean that TSMC can sell more semiconductors per unit of production while keeping costs the same. In other words, all else being equal, you should get a higher profit. If TSMC was unable to replicate Taiwan’s yields in Arizona, it risked significantly lower margins once all these new facilities came online. These concerns are now being addressed.
Demand for AI is not slowing down
These Arizona facilities, along with others in Japan and Europe, will be important to the AI market over the next five to 10 years. TSMC is perhaps the only company capable of manufacturing the most advanced semiconductors in the world today for companies like Nvidia, which is a major supplier of all data center spending related to the AI boom.
Simply put, as spending on AI increases, so will TSMC’s revenue. All of these new factories should help the company continue to meet insatiable customer demand. For example, last quarter, TSMC’s high-performance computing (HPC) division grew 11% quarter-over-quarter and now accounts for 51% of overall sales. In the same quarter just two years ago, the HPC segment accounted for only 39% of total revenue. HPC is investing in advanced semiconductors for data centers, namely AI.
Investors should track the HPC division closely, as it currently accounts for the majority of TSMC’s consolidated revenue and is growing at a ferocious rate. If spending on data centers and AI continues to soar, TSMC’s revenue will likely continue to grow rapidly. With wafer yields close to the same level as in Taiwan, profit margins should remain similarly high. Last quarter’s operating margin was a solid 47.5%, showing how valuable TSMC’s advanced computing products have become.
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Higher profit margins mean higher expectations
Given these strong sales and profits, TSMC’s stock price has begun to soar. Last year alone, the stock price rose more than 100%, and at one point its market capitalization was trading at more than $1 trillion.
These gains give the company a price-to-earnings ratio of 31x, a premium valuation slightly higher than the average of the S&P 500 index. Some investors will turn away from TSMC stock due to its high P/E ratio. However, I think this leaves the forest through the trees. Yes, TSMC has a high P/E ratio, but it has proven to be able to grow its earnings quickly over the long term, and has significant tailwinds from spending on AI. Over the past decade, the company’s earnings per share (EPS) have cumulatively increased by nearly 300%.
Despite this high valuation, I think TSMC stock is a buy even at this price if you believe in AI for the long term. The world’s leading companies continue to extend their lead and are now showing that their manufacturing processes can be replicated in other regions.
Brett Schaefer has no position in any stocks mentioned. The Motley Fool has positions in and recommends Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
