Followers of Warren Buffett know he's generally averse to technology stocks. Buffett typically takes big positions, and therefore seeks a high bar in terms of both valuation and conviction.
Since Buffett has admitted he's a novice when it comes to technology, it's no surprise to see few tech stocks in his portfolio, which totaled nearly $300 billion as of the third quarter. While Apple (AAPL -0.60%) is Berkshire Hathaway's (BRK.A -0.42%) (BRK.B -0.56%) largest holding, Buffett has said he sees that more as a consumer brand than a technology stock.
If tech stocks are typically avoided, that goes double for semiconductor stocks. Semiconductors are known to be cyclical, with frequent technology disruption being more of a rule than an exception.
However, could the semiconductor industry be changing for the better? In Berkshire's 13F filing, released Monday afternoon, Buffett's conglomerate revealed it took a big position in the world's largest semiconductor foundry, Taiwan Semiconductor Manufacturing (TSM 4.07%), making it Berkshire's 10th-largest position overall.
Taiwan Semi: Right out of the Buffett playbook
Buffett watchers know that Berkshire looks to buy companies with deep competitive advantages, attractive long-term growth prospects, and bargain valuations.
Taiwan Semiconductor appears to have all three elements. In terms of competitive advantages, it's the largest, most dominant semiconductor foundry in the world. According to Statista, it produced a stunning 53.6% of all semiconductors as of the first quarter of 2022. That market share is even higher on the most advanced chip nodes, where TSM vaulted past Intel (INTC 1.79%) in leading-edge production several years ago.
How did Taiwan Semiconductor do it? Well, this momentum has been a long time in the making, which probably makes it more durable.
Years ago, most semiconductor firms sought to separate their manufacturing from their design, since manufacturing was very capital-intensive. For instance, in 2008, Advanced Micro Devices spun off its foundry into what is now GlobalFoundries. By shedding the foundry business, semiconductor designers could focus on their research and development, thereby boosting margins and returns on capital without having to invest in costly manufacturing plants.
That enabled the foundry part of the industry to become concentrated and diversify its customer bases, as having more customers and scale would enable outsourced foundries to run at higher utilization, thereby boosting their economics as well.
Thus, Taiwan Semi attracted more and more top semiconductor designers, and its customers' diversity allowed it to compound semiconductor manufacturing knowledge at a faster rate. That, in turn, enabled Taiwan Semi, as a pure-play foundry, to surpass Intel, one of the last integrated designer-manufacturers, in leading-edge technology. Over time, semiconductor production has only gotten more challenging, giving TSM the opportunity to surpass the former leader.
New Intel CEO Pat Gelsinger has vowed to build out its own rival foundry and catch TSM within four to five years. However, that will be a long, expensive endeavor. Making things more complicated, Intel's main cash cow, its PC chip division, is in severe decline in 2022. That could delay or hamper the former leader's plans to catch up. Meanwhile, TSM is investing another $36 billion in its leading manufacturing footprint this year.
Flexing its pricing power in tough times
Taiwan Semi's status as the outright leader in semiconductor production gives it one of Buffett's favorite qualities: Pricing power. Amid inflationary concerns for raw materials, Taiwan Semi has been able to raise prices to its chip design customers throughout the past year, while also insisting on upfront payments when capacity was tight a year ago.
Even as the semiconductor market softened this summer, TSM refused to give refunds to customers that had pre-paid. Even a TSM customer as powerful as Nvidia (NVDA 4.00%) was forced to take a $1.3 billion inventory charge this summer, as TSM refused to cancel production of Nvidia gaming chips ordered earlier in the year. A report from earlier this summer also claimed TSM was insisting on faster payment terms from customers, to better finance its capital expenditures.
Despite many chip stocks running into softer results this summer, Taiwan Semi continued to deliver blistering growth. Revenue grew 35.9% in Q3 in dollar-terms, with a stunningly high net profit margin of 45.8% and a sky-high return on equity of 42.9%.
While most analysts think the semiconductor sector will decline next year, management has insisted that even if that occurs, TSM will still likely grow in 2023. This is due to its dominance in leading-edge technology, and demand for lagging-edge nodes for auto and industrial applications, which are still in high demand.
An opportunity came about in Q3
Finally, Buffett likely saw a tremendous bargain this summer, as TSM's stock fell after the PC sector went into freefall, China began saber-rattling over Taiwan following House Speaker Nancy Pelosi's visit to the island in August, and the U.S. unveiled restrictions on high-performance chip sales to China.
During these headwinds, TSM's stock fell to around current levels in Q3, then fell even further in early October, before recovering. That means Buffett likely bought shares at an equivalent or even higher price than shares are at now. Currently, TSM trades at roughly 15.5 times earnings and just 12.5 times next year's earnings estimates, with a 2.5% dividend yield. Shares are currently down 48% on the year and 51% from all-time highs.
Going up Apple's supply chain
Some may think the TSM purchase may have come from one of Buffett's younger lieutenants, Todd Combs or Ted Wechsler. However, if that's the case, it would be the largest of their positions, as every allocation larger than TSM in Berkshire's portfolio is a Buffett purchase. Thus, there's a good chance the TSM buyer is Buffett himself.
It's quite possible Buffett found TSM from his position in Apple. After all, TSM produces Apple's Bionic iPhone processors and M series laptop chips, so Buffett likely came to appreciate TSM's market position and pricing power through the Apple position. In October, the website MacRumors reported that even Apple had reluctantly accepted TSM's most recent price hike, after initially pushing back. According to Taiwan's Economic Daily News, "At present, not one of the IC design factories that received the price increase notice has refused."
It's a good sign for the semiconductor sector that Buffett's giving at least one stock in the space his seal of approval. The iShares Semiconductor ETF (SOXX 4.26%) is down 32% on the year, so it could use the help.