2 semiconductor stocks to buy now and 1 to avoid at all costs

The semiconductor industry has produced several growth stocks over the past 40 years that have created tremendous shareholder wealth. It’s a $600 billion industry that will continue to grow over the next decade, but investors must choose wisely. The advent of artificial intelligence (AI) tilts the advantage to some companies while exposing the weaknesses of others.

Here are two chip stocks to buy now and an industry stalwart to avoid.

Taiwan Semiconductor Manufacturing

Taiwan Semiconductor Manufacturing (TSM 0.33%)or TSMC for short, is one of the world’s leading chip manufacturers. It operates as a foundry, which means it produces chips for other companies, including Nvidia and Advanced microdevices (AMD 0.81%).

Its expertise in next-generation processing nodes translates into a profitable business with a high operating profit margin of 42%, more than double the 17% S&P 500 average.

Shares of TSMC are up more than 82% over the past year. The company’s second-quarter revenue in US dollars rose 33% year over year. Management expects strong demand in the third quarter to be supported by smartphones (it is a key supplier for Apple) and AI-related chips.

It is well-positioned for more growth as companies begin to introduce more AI features into mobile devices. Soft seasonality in smartphone sales contributed to TSMC’s weakest second-quarter market, so an improvement in demand would add to the momentum it’s experiencing in high-performance computing. From this point of view, the launch of Apple Intelligence together with the iPhone 16 this fall will be an important catalyst.

TSMC has seen annual revenue and earnings grow at high rates for many years. A $10,000 investment 10 years ago would be worth more than $100,000 today with the dividends reinvested.

It’s still a great buy, given that the stock’s forward price-to-earnings (P/E) ratio of 25 looks very attractive against Wall Street’s long-term earnings growth estimates of 26% per year. If those estimates hold, the stock could double in three years, assuming it continues to trade at the same P/E, which is likely given that it’s close to the S&P 500 average.

Advanced microdevices

The second chip stock to buy right now is one of TSMC’s key customers, Advanced Micro Devices. Of course, strong growth at TSMC reflects growing demand for semiconductors among its large customer base, and that’s good news for AMD shareholders.

After a recent pullback, the stock is up 26% over the past year. AMD is seeing accelerated growth in the data center segment, which is an important catalyst for the stock. Revenue from the segment doubled from the year-ago quarter to $2.8 billion, or nearly half of the company’s total revenue.

AMD also saw a huge improvement in its customer segment, including sales of consumer PC chips. Strong demand for Ryzen processors contributed to a 49% year-over-year increase in customer revenue last quarter.

This momentum shows that AMD is well positioned for growth in the AI ​​era. Management’s outlook calls for its data center graphics processing units (GPUs) to generate $4.5 billion in annual revenue, which it has collected over the past two quarters. AMD’s Ryzen chips should also see strong demand as AI-powered PCs roll out over the next year.

The stock currently has a forward P/E of 40, which seems reasonable given Wall Street’s long-term earnings growth estimate of 43% per year. Assuming AMD lives up to those expectations, the stock should be a very rewarding investment.

Why Investors Should Avoid Intel

Intel (INTC 0.87%) the stock has underperformed in recent years as it loses market share to AMD. Shares fell to multi-year lows after reporting poor second-quarter results, which included an announcement that it would suspend its dividend after reporting a string of losses over the past year.

Revenue fell 1% year over year in the second quarter. The client PC business grew 9%, while the data center and AI businesses were down 3% from the year-ago quarter.

These numbers are alarming against TSMC’s strong growth, which is the benchmark for industry demand. Intel is losing its innovative edge at a time when other companies are seeing explosive demand from the AI ​​arms race.

To its credit, Intel has executed a plan to regain industry leadership. It recently started production on its next-generation Lunar Lake AI chip, which will try to meet the need for more powerful chips for Microsofthis new Copilot+ PCs.

But the AI ​​server market is a major battleground in the chip industry, and AMD is on track to overtake Intel in data center revenue in the third quarter. Intel appears to have cut a hole in spending to grow its foundry business, which generates a third of the company’s revenue, while AMD continues to focus investment on building its long-term roadmap for high-performance processing technologies.

Intel’s collapse illustrates the importance of investing in companies with growing demand for their products. That’s why investors should avoid stocks right now and stick with companies that have the strongest growth, such as Taiwan Semiconductor and Advanced Micro Devices.