Are Taiwanese semiconductor stocks worth buying now?

taiwan semiconductor manufacturing (TSM -0.50%) It’s on a roll. TSMC is facing unprecedented production demands after three years of slump in chip manufacturing services. The surge in artificial intelligence (AI) that began two years ago looks like it will last for years, but that’s not all. Modern cars require large amounts of processors, and the smartphone market is emerging from a long slump.

In other words, TSMC’s stock price doubled in 2024. Its market capitalization has hovered around the rare $1 trillion level since October.

At the same time, TSMC stock is trading at a high valuation ratio. Is the stock overvalued today, or is TSMC still a bargain at today’s highs?

TSMC looks expensive

The company is engaged in hardware manufacturing industry. This is a high-tech business, a far cry from building houses, tractors, and industrial machinery, but it is still a relatively low-margin business that requires very large capital investments. Chip building facilities don’t grow on trees.

TSMC’s capital expenditures have peaked at $24.6 billion over the past four quarters. That’s more than Apple, Tesla, and Nvidia spent on capital expenditures combined.

Companies with expensive assets tend to grow much more slowly, and their stock valuations often trade at very low levels. For example, the top 10 industrial stocks currently trade at an average price-to-sales (P/S) ratio of 2.5x. TSMC’s stock price is valued at 12.8 times sales. The same is true for price-to-earnings ratios and price-to-free cash flow. TSMC’s stock price has soared at a historically high rate, making it look expensive compared to companies with similar business models.

TSM PS ratio data by YCharts

Why you still want to buy this expensive stock

The company backs up its relatively expensive stock valuation with solid business results.

After a temporary dip due to recent shortages of semiconductor materials and engineers, TSMC’s sales and profits are surging again. Its recently reported third quarter revenue increased 39% year-over-year. Net income increased by 54% over the same period, with cash profits increasing significantly. TSMC’s free cash flow nearly tripled, increasing 172% to NT$185 billion (approximately $5.7 billion in US dollars).

TSM Revenue (TTM) Data by YCharts

So, while you may be paying a premium for TSMC stock, TSMC is a world-class company and is definitely worth every penny of its high stock price. Growth-oriented valuation metrics look very reasonable, with a forward P/E of 23 times next year’s estimates and a price-to-earnings ratio (PEG) of 1.1. Both numbers suggest that the current stock price is neither extremely high nor particularly cheap, but at a reasonable level.

TSMC is a solid buy, but not for all investors

Taiwan’s semiconductor manufacturing giant is an attractive buyer in many ways. TSMC is a good way to capitalize on the AI ​​boom without picking winners in the chip design battle. Don’t forget that almost all of the major AI accelerator specialists rely on the likes of TSMC for the actual manufacturing of their physical products. Regardless of who controls the hardware market in the long run, TSMC will likely benefit from the success of the AI ​​sector as a whole.

But first you need to get used to valuations based on stock growth. Otherwise, we recommend a low-cost chipmaker or perhaps an underrated AI software and services provider. TSMC may be a fine growth investment, but not every stroller on Wall Street has access to refined silicone.