Taiwan Semiconductor Manufacturing Company (NYSE:TSM), or TSMC, has one of the strongest economic moats of all stocks. The company dominates the global production of semiconductors and the manufacturing of advanced microprocessors. Personally, I’m moderately bullish on TSM, recognizing its important role in this booming sector and investor interest in the stock. However, I appreciate that geopolitics do matter, and sentiment can weaken fast on geopolitical worries.
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TSMC’s Effective Monopoly
TSMC is the world’s largest foundry company and holds a virtual monopoly on the manufacturing of semiconductors and advanced microprocessors. While many of us know Nvidia (NASDAQ:NVDA), Apple (NASDAQ:AAPL), and AMD (NASDAQ:AMD) as some of the biggest players in the chip sector, most of the segment’s chip production is outsourced to Taiwan-based TSMC.
The foundry company has a 60%+ share of the global market for contract chipmaking and has effectively built a monopoly over advanced microprocessors. A cornerstone of TSMC’s dominance is its business model as a pure-play foundry. Unlike other semiconductor companies that both design and manufacture chips, TSMC focuses solely on manufacturing.
Understandably, TSMC also benefits from scale. Outsourcing from the U.S. to Taiwan has represented a cost-efficient business model for many years, but the company’s sheer scale has allowed it to become a true behemoth and has allowed these efficiencies to compound.
Over the decades, the Taiwan-based firm has also honed its expertise and production efficiency, setting it apart from competitors. TSMC’s technological capabilities are unmatched, contributing to its economic moat. The foundry leads the industry in developing cutting-edge manufacturing processes and chip production, such as the 5nm and 3nm nodes. These advanced nodes are essential for unlocking the next generation of high-performance chips.
These ever-smaller and more technologically advanced nodes also allow TSMC to improve margins. The company is staying ahead of its peers and remains on track to deliver a 1nm node before the end of the decade.
TSMC’s Evolving Valuation and Geopolitics
I was actually a shareholder in TSMC until around early 2023, and that certainly appears to have been the wrong time to sell; indeed, TSM has gained 74.6% year-over-year. However, I wasn’t the only investor selling at that time. Warren Buffett’s Berkshire Hathaway (NYSE:BRK.B) also sold its $5 billion holding in the company, citing geopolitical factors. Being influenced by the great man, I decided to follow suit as sentiment towards the Taiwanese company had turned rather negative.
Buffett explained that Berkshire had sold TSMC because of rising geopolitical risk. “Marvelous people and marvelous competitive position and everything, [but] I’d rather find it in the United States,” Buffett stated, noting that it was one of the best-managed and most important companies in the world.
In February 2023 — I had written an article on the stock that month — TSMC was trading at 14x earnings, which represented a considerable discount to its peers. However, today the stock trades at 33.1x earnings and 21.7x forward earnings. So, what’s changed?
There are several things to unpack within this evolving valuation. Firstly, it’s worth noting that earnings were actually stronger in 2022 than 2023. This is because 2022 represented the height of the chip shortage, and TSMC was able to cash in.
However, it’s equally the case that the company’s prospects have improved, and the growth forecasts with it, as a result of the revolution in artificial intelligence (AI). Basic normalized earnings per share (EPS) came in at $6.25 in 2022 and $5.36 in 2023, and this is expected to surge throughout the medium term, hitting $6.36 in 2024, $7.97 in 2025, and $9.34 in 2026.
This resurgence is already visible. The Taiwanese firm delivered market share gains and record results in Q1. Analysts are expecting earnings to grow by 23.8% annually over the medium term, and in turn, that leads us to a forward price-to-earnings-to-growth (PEG) ratio of 1.15. That’s very attractive and represents a 42.9% discount to the sector.
However, TSMC’s discount is reflective of the geopolitical concerns facing the company and investors. The Chinese government has consistently reiterated its desire to bring the island of Taiwan under its control and continues to violate the nation’s sovereignty with regular incursions into Taiwanese airspace.
I believe it’s worthwhile noting that even the best geopolitical consultancies accept they’re often wrong. However, the trajectory of Chinese claims over Taiwan will inevitably impact the business and its share price.
Is TSMC Stock a Buy, According to Analysts?
On TipRanks, TSMC comes in as a Strong Buy based on nine Buys, zero Holds, and zero Sell ratings assigned by analysts in the past three months. The average TSMC stock price target is $178.13, implying a 2.49% upside potential.
The Bottom Line on TSMC Stock
I’m fairly bullish when it comes to TSMC stock but I appreciate that sentiment is fickle, even with a mega-cap stock like this. The stock has surged on the back of the AI revolution and anticipated demand for its latest, and higher margin, semiconductors and advanced microprocessors. However, sentiment can change in a flash, especially on geopolitical events. As Warren Buffett said, it’s an amazing business, but geography presents several challenges.
