How Taiwan Semiconductor (TSMC) is Undervalued Right Now

Taiwan Semiconductor Manufacturing Company (NYSE:TSM) is widely regarded as the most important semiconductor company in the world. It’s the largest contract chipmaker, producing the vast majority of the world’s advanced microchips, including those for tech giants like Apple, NVIDIA, and AMD. Despite this dominant position in the semiconductor industry, many analysts and investors believe TSMC is currently undervalued. This article explores why TSMC’s stock is trading below its true potential, what factors contribute to this undervaluation, and why this presents an opportunity for long-term investors.

1. Global Importance of TSMC

TSMC's importance in the global economy cannot be overstated. The company has a virtual monopoly on high-end semiconductor manufacturing, which is essential for modern technologies. From smartphones to artificial intelligence (AI) applications, self-driving cars to advanced military systems, TSMC plays a pivotal role in almost every aspect of technological advancement. As of 2023, TSMC holds about 56% of the global foundry market share, with competitors such as Intel and Samsung trailing significantly behind in terms of technological capabilities and production capacity.

The company’s most advanced chips are fabricated using 3nm and 5nm process technologies, which are critical for the performance and efficiency of the latest consumer electronics. As demand for semiconductors continues to grow with the increasing adoption of AI, 5G, and Internet of Things (IoT) technologies, TSMC is well-positioned to benefit from these macro trends.

2. Strong Financials and Profitability

TSMC has consistently demonstrated strong financial performance over the past several years. Its revenues have grown steadily, and its margins are among the best in the semiconductor industry. In the Interim Q2 2024, TSMC posted revenues of TWD 1.27 trillion, an increase of 27.96% year-on-year. Its net profit also rose by 21.75% to TWD 473.3 billion. The company’s gross margins have also remained robust, hovering around 50%, while net profit margins have typically ranged between 35% to 40%. This is a remarkable achievement in an industry that is notorious for its capital intensity and cyclical nature.

Furthermore, TSMC’s strong balance sheet provides additional comfort to investors. The company is virtually debt-free, with a significant cash position. This financial stability allows TSMC to weather potential downturns and continue investing in cutting-edge research and development (R&D), ensuring its long-term competitiveness.

3. Global Geopolitical Risks Impacting Valuation

One of the main reasons TSMC may be undervalued right now is due to geopolitical tensions, particularly between the U.S. and China. Taiwan, where TSMC is headquartered, finds itself at the center of increasing geopolitical risks, as China has never ruled out the possibility of reunification with Taiwan, even by force if necessary. This geopolitical uncertainty has caused some investors to discount TSMC’s stock, as a potential conflict in the region could disrupt the company’s operations.

While these concerns are valid, they may be overblown when considering the global importance of TSMC. Both the U.S. and China heavily rely on TSMC for their technological and economic growth. For example, many U.S. companies such as Apple and NVIDIA source their chips from TSMC, while Chinese tech firms are also major customers. Any significant disruption to TSMC’s production would have far-reaching consequences for the global economy, making a military conflict less likely in the short to medium term.

Moreover, TSMC has been proactive in mitigating these geopolitical risks by diversifying its manufacturing footprint. The company is building new fabs in the United States and Japan, which should help reduce its dependence on Taiwan and provide some security against potential geopolitical disruptions.

4. Supply Chain Issues and Recovery

Like many companies in the semiconductor industry, TSMC has faced supply chain challenges in recent years, particularly during the COVID-19 pandemic. The global chip shortage caused significant disruptions across various industries, from automotive to consumer electronics. However, TSMC has been able to navigate these challenges more effectively than most of its competitors due to its scale and expertise in chip production.

Despite these supply chain issues, the demand for semiconductors has not diminished. In fact, it is expected to grow significantly in the coming years as more industries digitize and require advanced chips for everything from AI to autonomous vehicles. TSMC’s ability to scale its production capacity to meet this growing demand positions the company for long-term growth, further underscoring its value.

5. Industry Cyclicality and Market Sentiment

One of the perennial challenges of investing in semiconductor companies is the cyclical nature of the industry. Periods of high demand for chips are often followed by oversupply, which leads to price declines and shrinking margins. This cyclicality can cause significant volatility in the stock prices of semiconductor companies, including TSMC.

However, the current phase of the semiconductor cycle may be different. The increasing complexity of semiconductor manufacturing, driven by the move toward smaller and more advanced nodes (e.g., 3nm and 2nm), means that fewer companies can keep up with the required technological advancements. This has allowed TSMC to maintain its dominant position and protect its margins, even during downturns in the semiconductor cycle.

Despite this, market sentiment has often been bearish on TSMC due to fears of a cyclical downturn. These concerns may be overstated given the ongoing secular demand for chips in areas like AI, data centers, electric vehicles (EVs), and 5G. As a result, TSMC’s stock may be trading at a discount to its intrinsic value due to an overly pessimistic view of the semiconductor cycle.

6. Valuation Metrics and Comparisons

When comparing TSMC to other major tech companies, its valuation metrics suggest that the stock is currently undervalued. As of 2024, at $174/share TSMC is trading at a forward price-to-earnings (forward P/E) ratio in the low 20s, significantly lower than many of its peers in the technology sector, such as NVIDIA and AMD, which often trade at much higher multiples. This disparity in valuation seems unjustified, considering TSMC’s critical role in the global semiconductor supply chain, its robust profitability, and its market dominance.

Additionally, TSMC's price-to-sales (P/S) ratio is also relatively low compared to other high-growth tech companies. This presents an attractive entry point for long-term investors, especially when considering TSMC’s continued investment in cutting-edge technology and capacity expansion.

7. Growth Opportunities in AI, 5G, and Automotive Sectors

TSMC’s future growth prospects are bright, driven by several key trends in the tech industry. The rise of AI is perhaps the most significant of these trends, as AI applications require massive computing power and specialized chips. TSMC is already the leading manufacturer of AI chips for companies like NVIDIA and Google, and this market is expected to continue growing exponentially in the coming years.

The rollout of 5G technology is another major driver of demand for semiconductors, as 5G networks require more advanced and efficient chips for both infrastructure and devices. TSMC is well-positioned to benefit from this trend, as it produces the chips that power many 5G-enabled smartphones and base stations.

Lastly, the automotive industry is undergoing a significant transformation as electric vehicles (EVs) and autonomous driving technologies become more prevalent. These technologies rely heavily on advanced semiconductors, and TSMC is already a key supplier for many automotive companies. As EV adoption accelerates and autonomous vehicles become more mainstream, TSMC will likely see increased demand for its chips from this sector.

Conclusion

Taiwan Semiconductor Manufacturing Company (TSMC) is a technological powerhouse that remains undervalued in the market today. Its strong financials, global importance, and dominant position in the semiconductor industry are being overshadowed by concerns over geopolitical risks and market cyclicality. However, for long-term investors, these factors may present an opportunity to buy into a world-class company at a discount. With growth opportunities in AI, 5G, and automotive sectors, TSMC is poised to benefit from secular trends that will drive demand for advanced semiconductors in the years to come.