Nvidia shocked the investment world when discussing its future revenue guidance thanks to the massive demand for generative artificial intelligence (AI). This will allow Nvidia to sell more graphics processing units (GPUs), the hardware used to train AI models.
Instead of buying Nvidia, a grossly overvalued stock, investors should look one step down the value chain at its suppliers. Because Nvidia is a fabless manufacturer (it doesn't make its own chips), it has to rely on companies like Taiwan Semiconductor (TSM -1.75%) to produce what it needs. Instead of Nvidia, TSMC looks like a great place to invest.
Always creating the next-best chip
Don't think that you're outsmarting all of Wall Street by investing in Taiwan Semiconductor -- the stock popped 12% the day after Nvidia's announcement. However, unlike Nvidia, the stock is still valued at a reasonable level.
Taiwan Semiconductor is the world's largest semiconductor foundry and makes chips for giants like Nvidia, Advanced Micro Devices, and Apple. With these key companies, Taiwan Semiconductor has a client base that will always demand the most innovative products.
Luckily, innovation is what TSMC is known for. The company has always been at the leading edge for the most powerful chips globally. Although its 5 nanometer (nm) and 7 nm technologies are impressive, TSMC is still ramping up production for its 3 nm chip line, producing another powerful revenue stream for the business.
Even though it still hasn't fully launched its latest and greatest technology, TSMC is already working on its next greatest invention: 2 nm chips, which promise a 30% performance increase over the already cutting-edge 3 nm chips and is planned to launch in 2025.
With TSMC's known history of innovation plus supplying some of the most vital technology companies worldwide, the company's story is compelling. But how are its finances?
Short-term headwinds should ease
Taiwan Semiconductor's finances haven't been as strong lately. The company is feeling pressure from the lack of PC and smartphone demand, causing revenue to shrink by 4.8% in U.S. dollars. Furthermore, its second-quarter guidance wasn't much better, as management guided for a 15% revenue decline.
However, that was before Nvidia gave its monster guidance, so investors may see a slight beat. Even though times are tough right now, Wall Street analysts don't expect that to last, as the average projection for 2024 revenue is 22% growth.
This short-term pessimism has weighed on the stock as it's trading at a relatively low valuation compared to its historical norms. At 15 times earnings, the stock looks like a bargain, especially when compared to Nvidia's 201-times-earnings price tag.
TSM PE Ratio data by YCharts
Should you purchase the stock, know that TSMC's earnings are expected to fall throughout 2023, which will inflate this metric to make the stock look overvalued. However, the growth story for TSMC isn't just over the next year; it includes years of growth from innovative product launches.
With TSMC a vital supplier for tech giants like Nvidia and Apple, the stock has a bright future. And with processes that almost no competitors can duplicate, TSMC operates as an earned monopoly, which makes it a solid long-term investment.
