Much has been said about Warren Buffett's Berkshire Hathaway (BRK.A 0.19%) (BRK.B 0.15%) plopping over $4 billion on Taiwan Semiconductor Manufacturing (TSM 1.38%) last summer, only to sell most of those shares a few months later (and all the rest in this year's first quarter, according to Berkshire's new 13F filing).

Buffett and longtime business partner Charlie Munger have shared their thoughts on what happened. However, at Berkshire Hathaway's 2023 annual meeting, Buffett offered a little more insight into Berkshire's decision on the world's largest contract chipmaker, and what he would be looking for in an alternative semiconductor stock.

Buffett says TSMC is like no other, but...

When asked (again) about selling Taiwan Semiconductor (TSMC), Buffett reaffirmed that he likes the business -- a lot. In fact, Buffett said "[TSMC] is one of the best-managed companies and important companies in the world," and that "there's no one in the chip industry that's in [TSMC's] league, at least in my view."

You could also make a very solid argument that TSMC stock was dirt cheap the summer and autumn of 2022, and still is, at less than 13 times trailing-12-month earnings. With the entire semiconductor industry expecting a rally in sales in the back half of 2023 and into 2024, TSMC's earnings could be headed higher as soon as this summer, which would make the stock even cheaper (assuming stock price stays the same). That also satisfies Buffett's buying a "wonderful company at a fair price" criteria.  

So here's the catch: Buffett dislikes instability, and TSMC's location in Taiwan unsettles him. As I wrote a few months ago, it's possible that Buffett changed his mind after the U.S. CHIPS Act was passed last August. After that, the U.S. started dialing up its restrictions of advanced chips and chip manufacturing equipment to China. That, in turn, has led to rising China-U.S. tensions, as well as China's hints it might invade Taiwan to reunify it with mainland China.

Such an event would be disastrous for TSMC, not to mention the global economy and its reliance on the advanced chips TSMC makes.  

What does Buffett want in a semiconductor stock?

Buffett said he wants to find that wonderful business in the semiconductor industry like TSMC, but he wants to "find it in the United States."

Currently, as Buffett stated, there currently isn't anyone who can operate with the same level of chip manufacturing or financial precision of TSMC -- in the U.S., or anywhere else. Perhaps Intel can pull off a coup and retake the manufacturing crown, but that will be a very expensive multiyear process, if it succeeds at all. At least as far as semiconductor manufacturers go, don't count on Buffett buying anything anytime soon.

But manufacturing is just one area of the chip industry. There are high-quality, dominant names based in the U.S. That said, fair values are tough to come by. There's no way Buffett and company are ever going to invest in an Nvidia or AMD. Charlie Munger has expressed his dislike of companies like this that have to reinvest lots of cash into new research and development to maintain their technological edge, rather than return most of that cash to shareholders.  

However, the semiconductor manufacturing equipment makers are one corner of the chip industry that could fit all three of Buffett's metrics. Most of this space is dominated by just five companies:

  • Applied Materials (AMAT 2.05%)
  • ASML Holding (ASML 0.85%)
  • KLA (KLAC 1.70%)
  • Lam Research (LRCX 1.86%)
  • Tokyo Electron (TOEL.Y 2.61%)

These businesses have been around for decades and operate in an oligopoly. That means they face little in the way of competition, the entire semiconductor industry relies on their equipment to make chips, and they thus enjoy high rates of profitability.

Applied Materials especially fits the bill because it has the broadest range of tools covering all parts of the chipmaking process, it's valued reasonably (under 16 times trailing-12-month earnings), and it's based in the U.S. And it also pays a growing dividend and repurchases lots of stock.  

This is just my opinion on a stock that would fit within Warren Buffett's framework. As it stands right now, Berkshire Hathaway is continuing its aversion to high tech, focusing instead on more industrial companies with well-entrenched business models. If Taiwan Semiconductor Manufacturing doesn't make the cut for Buffett, I'm not sure any other business in the space will either.