Huge news came out over a month ago when Berkshire Hathaway (BRK.B 0.11%) -- the company run by Warren Buffett -- reported it had made a $4 billion investment in Taiwan Semiconductor Manufacturing (TSM +1.97%), otherwise known as TSMC.
The stock is now Berkshire's 10th largest position by market value, making it a meaningful purchase for the investing legend. Clearly, the Oracle of Omaha sees a lot of value in the computer chip manufacturer at today's prices.
Should you go along with Buffett and buy shares of TSMC in 2023? Let's investigate.
Taiwan Semiconductor: The world's chip factory
TSMC is one of the largest and most important companies in the world. It is a semiconductor foundry, which means it has built factories to manufacture semiconductors and computer chips for other companies like Apple and Nvidia. Since starting its business a few decades ago, TSMC has come to dominate the semiconductor market and now makes up more than 50% of the foundry industry.
Given how large the semiconductor industry is, TSMC's dominant market position makes it one of the largest companies in the world. Over the last 12 months, it has generated $72 billion in revenue, up from less than $20 billion 10 years ago.
There's no reason to think this growth is slowing down anytime soon, either.
Large growth opportunity with minimal competition
All indications are that the demand for semiconductors will steadily grow this decade. Modern technologies like smartphones, the cloud, the Internet of Things, artificial intelligence, and even electric vehicles are powered by computer chips. In order to fulfill this demand, TSMC has plans to spend tens of billions in capital expenditures every year to build out new manufacturing capacity around the globe.
NYSE: TSM
Key Data Points
Management is projecting that TSMC will spend a whopping $36 billion on capital expenditures, with more coming in the years after. In Arizona, TSMC has committed to spending $40 billion building a United States manufacturing hub that will start operations for customers in 2024.
Within the advanced chips market, TSMC has little to no competition due to its economies of scale and research expertise built over decades. It also has strong partnerships with semiconductor equipment companies like ASML that give it advantages in building cutting-edge computer chips for companies like Apple.
For example, right now, Samsung is the only company that has matched TSMC's five-nanometer chip technology, leaving companies like Intel in the dust. With only one true competitor at this time and a huge addressable market, TSMC has a clear path to steadily growing its revenue this decade.
TSM Net Income (TTM) data by YCharts.
But what about the valuation?
When Buffett buys a stock in size, you can be assured it is not trading at an expensive valuation. This is the case with TSMC right now. At its current market cap of $376 billion and with $30.5 billion in trailing-12-month earnings, the stock trades at a price-to-earnings (P/E) ratio of 12.3, which is well below the current average for the S&P 500 of 20. This looks cheap on any measure if you take into account the huge growth potential for TSMC over the next decade.
So what's the catch? Why are investors like Buffett able to buy TSMC at such a cheap valuation? One word: China.
China has been increasingly adversarial with TSMC's home country of Taiwan in recent years, which some investors see as a major risk to its operations. Management is working to diversify away from Taiwan with its new investments in the United States, but there will likely always be geopolitical and war risks when investing in TSMC.
If you are comfortable with this risk, now could be a great time to buy the stock at a low P/E. Otherwise, you should probably avoid adding the company to your portfolio.
