Is Taiwan Semiconductor stock a buy now?

Taiwan Semiconductor (TSM -4.20%) can be the one most important company in the world. It is a contract chip manufacturer, and the incredible technology from Nvidia, AMDor Apple it would not be possible without its chip foundries. With the stock down about 10% from its all-time highs, is it time to capitalize on this low price and buy Taiwan Semi shares?

TSMC has best-in-class technology

Taiwan Semiconductor has long been a leader in chip manufacturing. Because of its neutral position as a manufacturer, it doesn’t matter which company has the best product — it will benefit from the overall rising tide of more advanced technology being adopted.

TSMC is one of the few companies that can produce 3nm (nanometer) chips, which are the most powerful varieties available. The distance these chips are named after corresponds to the distance between the traces on a chip. For comparison, a human hair is about 80,000 to 10,000 nanometers thick — this should give investors an idea of ​​how small these chips can be made.

As the trace spacing decreases, more logic or transistors can be packed onto a chip. This prompts companies like Taiwan Semi to innovate and release even more powerful chips.

The next generation of chips is already under development, with TSMC’s 2nm chip scheduled to reach production in 2025. Management is very excited about this technology as pre-production demand for these chips exceeds 3nm demand and 5 nm.

While its 2nm chips can be configured for more processing power, the real improvement comes from power efficiency. When configured for the same computing power, these chips are expected to consume 25% to 30% less power than previous-generation chips. Given that input power is a massive cost for computing servers dedicated to training artificial intelligence (AI) models, it’s no mystery why these chips will be in high demand.

Since Taiwan Semiconductor works with almost every company that needs chips, it is set to benefit massively over the next few years.

High growth is expected over the next few years

While management does not provide exact guidance for its fiscal years, it is expected to grow revenue at a compound annual growth rate (CAGR) of 15% to 20% “over the next few years.” That’s massive and sustained growth for a company the size of TSMC, but it’s not hard to see how it could do that given the massive demand for its chips.

This is largely due to the increased demand for AI computing power. Management expects this segment to grow at 50% CAGR through 2028, when it will account for more than 20% of its total revenue. That’s a big runway, but what would that do for its share price?

Let’s assume that TSMC can achieve a revenue CAGR of 15% between now and 2028, while maintaining its current 38% profit margin. In four years, that would mean TSMC would generate $134 billion in revenue and $50.9 billion in profits.

Using Taiwan Semi’s decade-long average price-to-earnings (P/E) ratio of 20 as a base valuation case would mean the stock has a 14% upside to here.

TSM Data PE Report by YCharts.

This is not a very attractive investment, especially considering that it would take four years to get back to that level. If we change the assumptions so that TSMC’s revenue grows at 20% and the trailing P/E ratio is at 24 (its five-year average), then this advantage increases to 63%. This equates to a share price CAGR of 13%, which would outperform the long-term market average.

Still, TSMC would have to perform at the peak of its expectations to achieve this, which doesn’t leave much margin for error. But with massive growth slated for TSMC, I still think this could be a buying opportunity for the stock. Investors should be aware of the high expectations embedded in the stock’s current price, even though it is still down 10% from its all-time highs.