What happened
Shares of leading-edge foundry Taiwan Semiconductor Manufacturing (TSM -3.45%) and its equipment suppliers ASML Holdings (ASML -3.32%) and KLA Corporation (KLAC -2.49%) rallied during the month of May, rising 11.2%, 17.1%, and 14.6%, respectively, according to data from S&P Global Market Intelligence. All three companies reported earnings in April, but second-quarter guidance from Nvidia (NVDA -10.01%) on May 24 lifted all three stocks, as each of these names plays a key role in manufacturing Nvidia's chips.
Given the high enthusiasm over Nvidia's guidance and the outlook for strong multiyear growth in artificial intelligence (AI) applications, it's no surprise these chip manufacturing stocks were riding high last month...and it looks as if the positive trend may continue.
So what
On May 24, Nvidia reported its first-quarter earnings. While its Q1 earnings came in above expectations, it was really management's blowout second-quarter guidance that catapulted the stock higher along with other related semiconductor names.
AI technology and capability seem to have hit a tipping point, leading to a rush of investment by large enterprises and start-ups to capitalize on these newfound capabilities. While the release of ChatGPT last November seemed to have jump-started awareness, it appears massive investments are now kicking in about six months later.
That should be a boon for sales of AI-related chips, especially leading-edge Nvidia GPUs. And if the AI investment tsunami is good for Nvidia, it will also be good for TSMC, which manufactures the vast majority of the world's leading-edge semiconductors, Nvidia H100s included.
In fact, there were reports from as far back as March from industry publication DigiTimes that TSMC was seeing Nvidia ramp its pace of orders. However, with the overall semiconductor downturn outside of AI chips ongoing, there wasn't much talk of a surge in TSMC's growth back then.
However, with Nvidia's guidance and a May 26 DigiTimes report saying TSMC was now seeing a surge of "super hot runs (SHR)" for Nvidia chips, TSMC's stock finally responded. While AI servers make up less than 10% of today's overall server market, TSMC's skew toward the most advanced leading-edge chips is likely helping the stock defy the broader downturn.
While Nvidia depends on TSMC's manufacturing capabilities, TSMC, in turn, depends on ASML, which has a monopoly on key extreme ultraviolet (EUV) lithography technology needed to make any chip node below 10nm. In addition, the production of leading-edge chips is heavy on the use of metrology, or process control, which measures the accuracy of chip transistor layers and other parameters through every step of the mind-bogglingly complex process. KLA Corporation is the dominant leader in process control, with over 50% market share.
So it wasn't surprising to see both ASML and KLA Corporation rallying along with TSMC. After all, each stock is much cheaper than Nvidia, and neither has clawed its way back to the late 2021/early 2022 highs yet.
TSM Percent Off All-Time High data by YCharts. PE Ratio = price-to-earnings ratio.
Now what
To that last point, the semiconductor industry is at an interesting point right now. While experiencing the worst-ever decline in PCs, one of the worst-ever declines in smartphones, and softness in general computing servers, there is also solid growth in auto and industrial chips. And we appear to be at the beginning of a boom in AI servers.
The semiconductor sector is notoriously cyclical, but it's projected to grow faster than the economy through this decade, largely due to the megatrends of AI and electrification. Given that we now may be at the bottom of the post-pandemic bear market in semis, it's probably not too late to buy the stocks of leading chip manufacturers and equipment providers, with an eye toward the long term. While Nvidia trades at a frothy-looking 200 times earnings, these other AI plays don't.
