Taiwan Semiconductor (TSMC) (TSM -3.55%) provokes mixed emotions among investors. On the one hand, the company has taken the technical lead above all other third-party foundries.
However, the proximity of its foundries to China stokes geopolitical fears among some investors. This became most notably evident when Warren Buffett's team at Berkshire Hathaway bought TSMC stock only to reverse course within two quarters.
Still, investors may have stumbled on a way to balance those two concerns. Thanks to the breadth of TSMC's client base, many investors deal with this problem through indirect ownership of TSMC.
How to buy indirect ownership
Indirect ownership involves buying stock in a TSMC client rather than TSMC itself. Clients such as Apple, Nvidia, and AMD design chips. TSMC merely acts as one of their manufacturers.
Also, TSMC manufactures chips for these companies primarily in Taiwan. Due to Taiwan's proximity to China, some worry that this could interfere with TSMC's ability to conduct business. If TSMC can no longer manufacture chips in China, the technological advancement of its clients could come to a virtual standstill.
Yet, investors seem to ignore that risk when buying the stocks of chip designers. The most notable investors looking past this issue may be Warren Buffett, whose company owns 6% of TSMC's largest client, Apple.
The benefits and downfalls of indirect ownership
Nonetheless, investors should remember that TSMC controls the most advanced production. This likely helped boost the company's market share in the third-party industry to about 60%.
However, the geopolitical worries and the downturn in the chip industry have taken a toll on TSMC stock. Despite the company's technical prowess, the stock commands a price-to-earnings (P/E) ratio of only 16. Of the largest chip companies trading on the U.S. market, only Qualcomm has a lower earnings multiple.
Admittedly, the low cost of TSMC stock could attract investors. It supports a market cap of more than $530 billion, which is evidence of long-term growth in itself. Moreover, before revenue growth slowed to 4% in the first quarter of 2023, it came in at 43% in 2022. This is a rapid rate considering the low P/E ratio.
Investors should also remember that 40% of third-party chip manufacturing takes place outside of TSMC. To this end, companies like Samsung, GlobalFoundries, and Intel provide an alternative.
This means that if TSMC disappears tomorrow, the clients could still have a business. In fact, the second-largest foundry business in Taiwan, UMC Microelectronics, earns most of its revenue from less advanced chips. Hence, such competitors can reduce their dependence on TSMC even if they cannot completely replace it.
Indirect investing in TSMC
Given the state of the market, investors should probably follow Buffett's lead and pass on a direct position in TSMC. Indeed, it holds a technical lead and has become inexpensive from a price-to-earnings standpoint. Assuming the company avoids becoming a pawn in geopolitical entanglements, the stock could rise.
However, its area of the world has become increasingly dangerous, adding to the semiconductor stock's risk. Moreover, the more prominent chip design companies like Apple, Nvidia, and AMD have commanded premium valuations. They also have some latitude to turn to other chip manufacturers. Those factors make the design companies both safer and more lucrative stock picks.