AI-related chip demand has far outpaced expectations.
Taiwan Semiconductor Manufacturing (TSM 2.78%) has been on fire recently. After the company reported Q3 results on Oct. 17, the stock jumped 10% on the strength of the business.
A pop like this may discourage some investors from buying Taiwan Semi stock because they think they’ve missed the boat. However, that’s far from the case, as there are still multiple strong reasons to buy the stock, even after the market’s reaction to earnings.
New technology will sustain TSMC’s growth for many years
Taiwan Semiconductor is the world’s leading chip manufacturing company. It makes chips that go into Apple‘s iPhones, Nvidia‘s graphics processing units (GPUs), and basically any other technologically advanced device.
Because Taiwan Semi is a chip fabricator, it isn’t choosing sides in any of the current technological races. Instead, an investment in Taiwan Semiconductor is essentially a bet that consumers will use more advanced digital devices in the future. This seems like a no-brainer investment, and the company’s results back that up.
In Q3, Taiwan Semi’s revenue rose 36% year over year to $23.5 billion. Twenty percent of that revenue came from 3-nanometer (nm) chip technology, the company’s most advanced product. It’s quite impressive to ramp up this quickly because 3nm chips only started contributing to Taiwan Semi’s revenue in Q3 of last year.
That also should get investors excited for TSMC’s next launch, 2nm chips. N2 chips are expected to launch in 2025 and ramp up in 2026, and this technology is expected to provide massive efficiency gains. While these chips will only provide a 10% to 15% power boost when configured to consume the same amount of energy, they provide a 25% to 30% efficiency boost when configured at the same power level as 3nm chips.
With power consumption (especially with artificial intelligence (AI)-related chips) becoming a big deal, these 2nm chips and the products they go into may become must-have upgrades as they could pay for themselves from energy savings. Preliminary 2nm chip demand is already outpacing its predecessors (3nm and 5nm technology), so it’s clear its customers are also excited about this launch.
Although this isn’t set to launch until 2025 (with a ramp up in 2026), it lets investors know that a 10% one-day movement in TSMC stock isn’t a reason to avoid buying the stock. New products are bringing massive tailwinds, and TSMC hasn’t begun to scratch the surface of how AI-related chips will boost its business.
AI chips are in high demand
In Q1, management guided that AI-related chip sales would expand at a 50% compound annual growth rate (CAGR) for the next five years. After that growth, they expected it would make up more than 20% of the company’s total revenue.
However, that projection may have been a tad slow. Just two quarters later, management raised its forecast that AI chips would make up a mid-teens percentage of its revenue in 2024 because revenue has more than tripled year over year. This shows how huge AI is becoming for the company, and it’s fairly evident it will become more than 20% of Taiwan Semi’s business much faster than they expected.
All of this AI-related enthusiasm has inflated TSMC’s valuation, pushing its valuation up to 32 times trailing earnings and 23 times 2025 earnings.
TSM Price-to-Earnings Ratio data by YCharts.
Historically, this is a pricey valuation. However, Taiwan Semi is also ramping up to some of the fastest growth it has experienced in the past decade. With Wall Street analysts projecting 25% growth in 2025, the valuation resembles 2021 and 2022, when it grew rapidly for multiple years.
TSM Operating Revenue (Quarterly YoY Growth) data by YCharts.
COVID-related chip demand drove TSMC’s sales during those years, but its revenue cratered when that demand was filled. I don’t expect AI demand to experience that same drop for some time, so paying a slightly elevated price tag for Taiwan Semi’s stock is OK with me.
Taiwan Semiconductor isn’t quite a value play but has a ton of growth ahead. As a result, I’m not worried about a one-day or one-month run as I’m focused on the long term. With TSMC’s long-term prospects looking great, I’m a confident buyer of the stock.
Keithen Drury has positions in Taiwan Semiconductor Manufacturing. The Motley Fool has positions in and recommends Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.