Taiwan Semiconductor (TSMC) Stock: Bear vs. Bull

Over the past decade, Taiwan Semiconductor Manufacturing's (TSM 1.26%) stock rallied nearly 450% as the S&P 500 advanced 170%. TSMC easily beat the market because it's the world's largest and most advanced contract chipmaker, and it fed the market's insatiable appetite for more powerful chips. The robust growth of TSMC's top customer, Apple, amplified those gains.

But does TSMC still have room to run over the next few years? Let's compare the bear and bull cases to find out.

Image source: TSMC.

What the bears will tell you about TSMC

The bears expect TSMC's near-term growth to remain sluggish as the semiconductor sector suffers a cyclical slowdown. Sales of new PCs and smartphones cooled off after the pandemic, while macro headwinds curbed the market's demand for new data center and enterprise chips. That's why TSMC's year-over-year revenue growth decelerated over the past three quarters.

Data source: TSMC. 

For the full year, analysts expect its revenue to decline 9% -- compared with its 34% growth in 2022 and 25% growth in 2021. As TSMC's revenue growth cools off, it still plans to spend $32 billion to $36 billion in capital expenditures this year to maintain its technological lead against its two largest rivals, Samsung and Intel. Its raw-material costs are also being inflated by the Ukrainian War. As a result, analysts expect its earnings per share (EPS) to drop 22% in 2023. 

But even with that elevated spending, there's still a chance that Intel and Samsung could catch up to TSMC with the help of some big government subsidies. TSMC intends to start mass-producing its smallest 2-nanometer (nm) chips in 2025, but Intel aims to reach its 2nm node by 2024 as Samsung tries to hit that milestone by 2025. If TSMC loses its process lead, many of its top customers -- including Apple, AMD, and Nvidia -- could start outsourcing more chip orders to Intel and Samsung.

Lastly, the escalating tensions among the U.S., China, and Taiwan could cause problems for the company. TSMC still produces its most advanced chips in Taiwan, which is exposed to attacks or blockades by mainland China. It's been opening new plants in the U.S. and Japan to address those concerns, but higher labor costs could prevent it from efficiently operating those fabs.

What the bulls will tell you about TSMC

The bulls will point out that TSMC survived plenty of cyclical slowdowns before. During its latest conference call, CEO C.C. Wei told investors that TSMC would pass "through the bottom of the cycle" during the second quarter. He also noted that the growth of the AI market would be likely to boost its high-performance computing revenue, and that expansion could create a "megatrend for TSMC's business growth in the future."

Wei also reiterated TSMC's long-term goal of growing its annual revenues at a compound annual growth rate of 15% to 20% in terms of U.S. dollars between 2021 and 2026. Looking past its slowdown in 2023, analysts expect its revenue and EPS to rise 22% and 25%, respectively, in 2024. So to the bulls, it seems futile to fret over TSMC's near-term slowdown. Instead, they'll tell you that the stock still looks reasonably valued at 20 times forward earnings.

As for Samsung and Intel, both companies have repeatedly tried but failed to catch up to TSMC in the process race before. That's because TSMC adopted ASML's extreme ultraviolet (EUV) lithography systems -- which cost about $200 million each and require multiple planes to ship -- long before either rival, with some financial assistance from Apple. EUV systems are required to produce the world's smallest and densest chips, and TSMC has a big head start at scaling up that cutting-edge technology and utilizing it more efficiently than its competitors. It also seems unlikely that big fabless chipmakers like Apple, which have stuck with TSMC for years, will abruptly switch all of their orders to Samsung or Intel.

The bulls will also tell you that while TSMC will be squeezed by tensions between the U.S. and China, an actual invasion or blockade of Taiwan would probably cause many tech stocks to crash alongside TSMC. So if you believe the worst-case scenario for TSMC will occur soon, it might be smarter to avoid stocks altogether and simply stick with fixed-income investments.

Which thesis makes more sense?

The bears and bulls both make valid points about TSMC, but I believe the bullish thesis is still a lot stronger. TSMC is still outspending Intel and Samsung by a wide margin, and it should keep locking in its customers with its best-in-breed reputation as the semiconductor sector gradually recovers. Its stock is still cheap, its future is bright, and it should remain a top play on the secular expansion of the semiconductor market for patient investors.