You can’t go five minutes without hearing about Nvidia these days. The computer chip giant recently became the world’s largest company by market capitalization and is now valued at over $3.34 trillion. Investors are betting that huge capital spending on artificial intelligence (AI) will continue, with Nvidia maintaining its dominant position in the market.
But which companies power Nvidia? There is one that stands above all others, and it is the most advanced semiconductor manufacturing backbone in the world. Enter Semiconductor manufacturing in Taiwan (NYSE:TSM)a company that powers Nvidia and the AI ​​revolution.
Is the stock a buy? Let’s take a closer look and find out.
Taiwan Semiconductor: the backbone of modern computing
Taiwan Semiconductor (TSMC for short) has risen above the pack in chip manufacturing thanks to its innovative foundry model. This means that TSMC does not sell the chips it makes directly to customers – IntelThe old business model of – but aggregates orders from computer chip designers. This allows it to focus solely on manufacturing expertise and maintain a lead in the world’s most advanced semiconductor manufacturing.
It has few or no competitors such as Intel, Samsung, and local Chinese players. Customers include Apple, Alphabet, Amazon, and the aforementioned Nvidia. With computing demand for new AI tools increasing, companies have had to buy chips from players like Nvidia or design their own. Almost all of them outsource this production to TSMC.
With minimal competition and huge switching costs, the company has a huge lock-in with customers and enormous pricing power that allows it to generate outsized profits. Over the past 1 year, operating profit has increased by almost 300% and reached $30 billion in the past 12 months. It generates just over $70 billion in revenue and reported 30% revenue growth in May as new orders arrive to meet booming AI capital spending.
Investors are banking on AI and geographic diversification
TSMC stock is up 439% over the past five years and has reached several all-time highs in 2024. Investors are betting that the AI ​​revolution will continue to drive the company’s growth over the coming years. Still, anyone looking to buy stocks today should wonder if the market isn’t a little overexcited about AI companies right now.
Some might see parallels with the dotcom bubble and AI stocks. Even though the Internet became one of the most important technologies of all time, that didn’t stop overvalued stocks from falling 90% when the bubble burst. Given its diversification across the entire semiconductor market, it’s hard to imagine a 90% decline for TSMC, but the risk of an AI bubble nevertheless persists.
Another potential tailwind for TSMC is geographic diversification. The company focuses its production on its own territory, which faces a growing risk of Chinese aggression. This would obviously be bad for shareholders.
To mitigate this risk, TSMC is working with countries like the United States to build factories outside of Taiwan. It recently received $6.6 billion from the US government and is building factories worth tens of billions of dollars in the country. This will help reduce the risk of invasion from China and boost growth over the next decade.
Price/earnings ratio TSM data by Y charts.
But is the stock cheap?
Less than two years ago, TSMC was trading at a price-to-earnings ratio (P/E) just above 10. Today, the ratio is about to exceed 35. Looking back, TSMC was clearly undervalued with a P/E below 10 years.
It’s hard to make the same argument when the stock is now at all-time highs. This is not a hypergrowth company that can instantly triple revenue. Yes, revenues are currently increasing due to AI spending, but that also comes with the risk of a bubble from new technology. Let’s not forget the Chinese risk either.
THE S&P500 is trading at a P/E of around 28. TSMC is well above that level, and it’s not like the market is cheap either. Considering all these factors, TSMC stock does not seem like a good stock to buy at these prices even though it is the backbone of the AI ​​revolution.
Should you invest $1,000 in semiconductor manufacturing in Taiwan right now?
Before buying Taiwan Semiconductor Manufacturing stock, consider this:
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Brett Schaefer holds positions at Alphabet and Amazon. The Motley Fool holds positions and recommends Alphabet, Amazon, Apple, Nvidia and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 calls on Intel and short August 2024 $35 calls on Intel. The Motley Fool has a disclosure policy.
1 Unstoppable Stock Powering Nvidia and the AI ​​Revolution was originally published by The Motley Fool
