Micron Technology (NASDAQ:MU) and Taiwan Semiconductor Manufacturing (NYSE:TSM) are two crucial players in the semiconductor market. Micron is one of the world's top producers of DRAM and NAND memory chips, which are widely used in mobile devices, PCs, data centers, and other electronics.

Taiwan Semiconductor, commonly known as TSMC, is the world's largest contract chipmaker and manufactures the world's most advanced chips for companies like Apple, NVIDIA, Qualcomm, and AMD.

An illustration of a semiconductor on a circuit board.

Image source: Getty Images.

Both stocks have generated big returns for investors over the past five years. Micron's stock has rallied more than 160% on robust demand for its memory chips across multiple industries, while TSMC's stock advanced over 150% on consistently strong orders from its top customers. Let's see which semiconductor stock has more room to run this year.

How does Micron make money?

Micron generates nearly all its revenue from different types of memory chips. DRAM chips accounted for 66% of its revenue last quarter. NAND (flash memory) chips generated another 31% of its revenue, and the rest came from other types of memory.

Micron faces three long-term challenges. First, it faces stiff competition from larger rivals, especially Samsung, in the DRAM and NAND markets. Second, demand for DRAM and NAND chips is highly cyclical, so Micron's revenue rises and falls sharply with market prices.

Lastly, the trade war's expansion into a tech war cost Micron its orders from Chinese tech giant Huawei, which generated 12% of its revenue in 2019, and is prompting Chinese chipmakers to produce their own DRAM and NAND chips to reduce the country's dependence on foreign chips. That shift could flood the market with cheaper memory chips and significantly depress market prices. 

How does TSMC make money?

TSMC generated 49% of its revenue from the smartphone market last quarter. Another 30% came from the HPC (high-performance computing market), 9% from the IoT (Internet of Things) market, 4% from the automotive market, 5% from the DCE (data communications equipment), and the remaining 3% from other markets.

Its production of high-end 7nm chips, which include the latest chips from Apple, AMD, NVIDIA, Qualcomm, and other top chipmakers, accounted for 35% of its revenue during the quarter -- up from 21% a year earlier. That growing mix of 7nm chips will boost TSMC's margins.

Like Micron, TSMC was forced to drop Huawei's orders, which likely accounted for 14% of its sales last year, amid the trade war. TSMC produces its most advanced chips in Taiwan, but it still produces its older chips in China -- which leaves it exposed to both the trade war and political tensions between Taiwan and China.

Which company is growing faster?

Micron's revenue surged along with higher memory prices in 2017 and 2018, but a supply glut, the loss of Huawei's orders, and slower sales of smartphones throttled its growth in 2019. TSMC generated more stable growth, but it also struggled with slower smartphone sales and the loss of Huawei last year.

Revenue Growth (YOY)

2015

2016

2017

2018

2019

Micron

(1%)

(23%)

64%

50%

(23%)

TSMC*

11%

12%

3%

6%

4%

YOY = Year-over-year. Source: Annual reports. *In New Taiwan dollars.

In the first three quarters of 2020, Micron struggled with soft demand from the auto, consumer electronics, and smartphone markets amid the COVID-19 crisis, which was only partly offset by stronger sales of chips for the notebook and data center markets.

Servers in a data center.

Image source: Getty Images.

However, Micron still expects those tailwinds, along with a dwindling supply of chips, to boost memory prices this year. Analysts still expect its revenue and earnings to decline 9% and 56%, respectively, this year, but for both figures to rebound to double-digit levels next year.

Micron's stock only trades at about 11 times forward earnings, even after rallying nearly 30% over the past 12 months on hopes of a cyclical rebound in memory prices. That low valuation suggests Micron still has room to run, despite facing tough competition in the NAND and DRAM markets.

Meanwhile, demand for TSMC's chips among its top customers should remain stable this year, as analysts expect several tailwinds -- including Apple's new iPhones and AMD's new chipsets for the PS5 and Xbox Series X -- to boost its revenue and earnings 15% and 24%, respectively.

Those are solid growth rates for a stock that trades at 21 times forward earnings. Unlike Micron, which doesn't pay a dividend, TSMC pays an attractive yield of about 3%.

The winner: TSMC

Micron and TSMC are both attractive semiconductor stocks. But if I had to pick one over the other, I'd stick with TSMC for its market-leading position in contract manufacturing, diverse customer base of tech titans, stable growth rates, and decent dividend. Micron, on the other hand, faces tougher competition, doesn't pay a dividend, and hasn't fully passed a cyclical trough yet.