Ark Invest CEO Cathie Wood missed out on Nvidia's recent explosive rally, having sold the semiconductor stock from her company's exchange-traded funds (ETFs) at the beginning of the year. While Wood hasn't changed her position on Nvidia, she is pursuing other AI-driven opportunities in the semiconductor space.
On Monday, Ark purchased 98,170 shares of Taiwan Semiconductor Manufacturing (TSM 1.26%) stock for its ARK Autonomous Technology & Robotics ETF. Why did Wood's company pour roughly $10 million into the semiconductor specialist, and is there still a buying opportunity for other investors?
Why does Wood like TSMC stock over Nvidia?
While there are many companies that design semiconductors, there are very few that actually have the capability to manufacture their own chips. Given the economics of semiconductor fabrication, it typically makes more sense for chip designers to outsource the production of their designs to a third-party foundry. Within the foundry space, TSMC is the strongest player.
- TSMC stands as the largest semiconductor manufacturer in the world.
- The company commands more than 60% of the total contract chip fabrication market.
- When it comes to ultra high-performance chips needed for AI and other intensive applications, Nvidia captures more than 90% of the fab market.
The Taiwan-based company's chip fabrication centers are the best in the world and have a reputation for reliably delivering product orders when customers need them. TSMC has also built a reputation for delivering high-quality products with very low defect rates.
Because semiconductors are central to so many products and services these days, the risk of order delays or chip failures is something that equipment manufacturers desperately want to avoid. Given its current leadership position in the fab space and strong competitive advantages, it's not surprising that Wood thinks TSMC is a smart way to play the rise of AI.
While Wood believes that Nvidia stock has gotten too expensive, investing in TSMC actually provides an alternative way to benefit from the processing leader's surging AI business. Like most top chip companies, Nvidia is a customer of TSMCs and relies on the fabrication leader to manufacture its semiconductor designs.
Thanks to increased AI-driven demand from Nvidia, TSMC is now reportedly using between 70% and 80% of production capacity for its 5-nanometer chip transistors. Previously, the company had been at somewhere about 50% production capacity for the category.
Should investors follow Wood into TSMC stock?
With Wood's flagship ARK Innovation ETF rising 42% this year and the Autonomous Technology and Robotics ETF climbing 36%, investors have started to pay closer attention to her company's stock purchases. Replicating every stock purchase made by Ark probably isn't sensible for most investors, but I think those looking to capitalize on the rise of AI should take a close look at TSMC.
Following an increase in bullish sentiment for tech stocks and rising excitement surrounding artificial intelligence, the fab leader's stock has risen roughly 43% across 2023's trading. But even after the impressive rally this year, the company doesn't look prohibitively valued.
TSM PE Ratio (Forward) data by YCharts
Despite surging across 2023's trading TSMC still trades at a reasonable-looking 21 times this year's expected earnings. The company also pays a dividend, with its forward yield working out to roughly 1.9% based on today's stock prices.
At its core, TSMC is a fantastically run business with powerful competitive advantages. Since going public in 1994, the company has grown revenue and earnings at 18% and 18.6% compound annual growth rates, respectively.
The chip fabrication industry is incredibly capital intensive, which will make it difficult for competitors to muscle in on the foundry leader's turf, and TSMC looks well positioned for long-term growth. From 2021 to 2026, the company expects to have grown revenue at a CAGR between 15% and 20%, recorded an average gross margin of 53%, and delivered a return on equity above 25%.
TSMC's foundries are going to play an essential role in pushing AI forward, and its diversified customer base means investors don't need to worry about picking winners among chip designers. With strong growth prospects and a reasonable valuation, the stock stands out as a strong pick-and-shovel play for benefiting from the rise of artificial intelligence and evolution of the semiconductor industry.
