Semiconductor stocks are an integral part of the future. The chips these companies produce are essential in electronic devices, enabling advances in communications, transport, computing, healthcare, military systems, and countless other applications.
Naturally, as part of a diverse portfolio, I feel that should have some exposure here. I already own shares in Taiwan Semiconductor Manufacturing Company (NYSE:TSM) but I’m looking to increase my exposure to the sector.
As it turns out, TSMC appears to be the pick of the bunch given its relative valuation and technology primacy. So maybe I should buy more. Let’s explore TSMC and one other.
Significantly discounted market leader
In 2022, Warren Buffett’s fund, Berkshire Hathaway, invested more than $4.1bn into TSMC. That’s normally a pretty good sign for investors — the Oracle of Omaha tends to know what he’s doing.
Buffett bought in at the end of a year in which the share price had slumped. The world’s largest semiconductor firm saw its share price fall from highs above $130 in 2021 to a low of $58 in 2022.
However, the company’s performance did not reflect this falling share price. TSMC posted extremely strong growth, with net revenue growing from $56bn in 2021 to $75bn in 2022 — an impressive 33% growth. Meanwhile, despite the sky-high inflation, gross margins improved from 51.6% to 59.6%.
TSMC growth is expected to slow to single digits in 2023, but this should be priced in. CEO C.C. Wei expects the market for semiconductor to bottom out in H1 before recovering in the latter half of the year.
Focusing on valuation, the Taiwan-based corporation trades with a price-to-earnings multiple of 14. That’s significantly below the information technology average of 24.6 and the semiconductor sector average of 15.8.
TSMC considerations
TSMC’s discounted valuation versus peers reflects a few things. Firstly, there are geopolitical concerns regarding Chinese desires over the island of Taiwan where the company is based. TSMC is expanding its geographical footprint, and this should reduce fears in the long run about Chinese aggression and its impact on the stock.
We also have to consider the impact of huge capital expenditure (capex) on earnings per share. TSMC spent $36.3bn in capex last year — that’s huge albeit slightly less than expected. The considerable spend reflects its strategy to diversify some manufacturing to other locations while moving to produce denser power-efficient chips — the investment required to introduce market-leading 3nm chips is expected to cost $32bn.
In the long run, analysts contend the movement to small, higher-margin chips will cement the company’s market-leading position. Right now, TSMC looks good value going forward, and that’s why I’d buy more.
One to keep my eye on
It’s not that I’m not interested in other listed semiconductor stocks. But I am excited by the potential IPO of ARM this year. After the $40bn takeover by NVIDIA collapsed, SoftBank Group — which owns ARM — will be looking for new ways to release value from the British semiconductor and software design business. It might not be the best time to list, after the tech crash of 2022, but it’s something I’m keeping an eye on.
