Semiconductor companies are cyclical and heavily influenced by macroeconomic factors. Massive research and development costs, upfront expenses to expand manufacturing capacity, and the constant push for innovation make it expensive to stay relevant. But for many companies, the risk is worth the reward because of the rapid growth in chip demand and applications.
Fortune Business Insights estimates that the global semiconductor market will grow at a compound annual rate of 12.2% between 2022 to 2029, more than doubling from $573 billion to nearly 1.4 trillion.
Nvidia (NVDA 3.65%) and Taiwan Semiconductor Manufacturing (TSM 2.84%) are two industry-leading companies at the forefront of the chip industry. But both stocks are down over 40% from their all-time highs due to a downturn in the industry. Here's why each company may be worth a look now.
Image source: Getty Images.
A bet on the future
Howard Smith (Nvidia): There's no doubt that Nvidia stock was given too much of a premium valuation based on the growth investors expected. That helps explain the more-than-50% drop from its highs in late 2021. That became especially clear when revenue growth in its largest segment sharply reversed course in the current fiscal year.
But the promise and potential that drove Nvidia shares to its unsustainable valuation weren't about the gaming segment, which was thriving at the time. And a transition has already begun that will see the data center, automotive, and artificial intelligence (AI) segments driving the company.
Data source: Nvidia financial filings. Chart by author.
While revenue from gaming chips was only half of what it was a year ago, Nvidia's data center business grew 31% year over year in the fiscal 2023 third-quarter period ended Oct. 30, 2022. An investment in Nvidia now is a bet on growing contributions from automotive and AI customers, who have increasing needs in autonomy, robotics, and data analysis.
And though Nvidia's dividend is minuscule compared to that of Taiwan Semi, the company has returned $9.3 billion to shareholders in the form of share repurchases over the first nine months of fiscal 2023. That represented just over half of what has been authorized for buybacks through Dec. 2023.
Nvidia and Taiwan Semi may not deserve the same share of a portfolio. A bet on Nvidia carries added risks that industries like autonomous vehicles and AI will mature and thrive. But for those willing to include a speculative investment with a lot of potential long-term upside, Nvidia's share price correction has now provided an opportunity.
Taiwan Semi is a layup for long-term growth
Daniel Foelber (Taiwan Semiconductor): Few companies hold a candle to Nvidia when it comes to dazzling growth and glamorous products. But what Taiwan Semi lacks in flare it more than makes up for with a lower valuation, a wider moat, and a higher dividend yield.
Taiwan Semi has a dirt-cheap forward price-to-earnings ratio of just 13.4, a dividend yield of 2.3%, and a 47% operating margin -- beating Nvidia in all three categories.
TSM PE Ratio (Forward) data by YCharts
Nvidia is one of the most innovative companies in the semiconductor industry. But it's a far riskier business model than Taiwan Semi.
Taiwan Semi is the world's largest pure-play chip foundry. You may be surprised to learn that a fabless chip maker like Nvidia doesn't actually make its own chips, much like Apple isn't actually making its iPhones. It relies on suppliers for that step.
Nvidia -- like basically every major player in the game -- relies on Taiwan Semi to make a sizable chunk of its products. So Taiwan Semi isn't really a competitor with Nvidia. In fact, Nivida is one of its main customers.
Instead, Taiwan Semi is competing with other chip foundries. The name of the game is providing services for the changing needs of customers at a low cost and a fast turnaround. Taiwan Semi isn't immune to competition. But no company comes close to its size and efficiency.
In this vein, Taiwan Semi is a far safer bet on the growth of the industry than any other chip maker. With Taiwan Semi, you're investing in the growth of chip production and usage, whereas with Nvidia, you're investing in a company that you think will spearhead technological breakthroughs.
For comparison, investing in a stock like Home Depot is a way to indirectly bet on the housing market instead of investing directly in a home builder. Or investing in Caterpillar is a good way to bet on construction, oil and gas, or mining instead of directly buying an exploration and production oil and gas stock.
Nvidia stock could outperform Taiwan Semi if it continues to out-innovate its competitors. But that is a relatively riskier proposition than just going with Taiwan Semi, which has a far better risk/reward profile than Nvidia.
Two good options worth considering now
Nvidia and Taiwan Semi operate on different sides of the semiconductor industry. Nvidia has done a masterful job of diversifying its business to include gaming, datacenter, AI, and autonomous vehicles. But for now, the AI and autonomous vehicle side of its business remains a sideshow, while data center and gaming performance are highly cyclical. That being said, Nvidia is positioned to outlast downturns while still being able to invest in multi-decade trends.
Meanwhile, Taiwan Semi is poised to continue outspending its competitors to retain its industry-leading manufacturing profile. As the industry evolves and becomes more complex, Taiwan Semi has the margins and cash flow necessary to make necessary improvements.
Aside from being different companies, both stocks have contrasting investment theses. Nvidia offers arguably more upside with its potential to be a leader in industries that could unlock untold value. But it's also a more expensive stock that lacks a meaningful dividend yield. By contrast, Taiwan Semi should enjoy steady growth in lockstep with the overall industry.
