The booming demand for chips to power artificial intelligence (AI) applications has sent Nvidia's (NVDA 6.18%) stock soaring in 2023, with shares of the graphics card specialist jumping 206% this year. But that also means that Nvidia's stock now trades at an extremely expensive multiple.
Nvidia's price-to-sales ratio sits at 45 right now, way higher than the company's five-year average sales multiple of 18. The price-to-earnings ratio of 243 is way higher than the Nasdaq-100 index's multiple of 35. While there is a good chance that Nvidia could justify its expensive multiples with a sharp increase in revenue and earnings in the current fiscal year and beyond, investors with a lower risk appetite may not be comfortable buying the stock at its current multiples.
This is where semiconductor foundry specialist Taiwan Semiconductor Manufacturing (TSM 1.26%) -- popularly known as TSMC -- comes into play.
TSMC cut its 2023 guidance, but that doesn't change the long-term narrative
TSMC reported its second-quarter 2023 results on July 20. The company's revenue fell 14% year over year to $15.7 billion, while adjusted earnings fell 26% over the prior-year period to $1.14 per share. TSMC management attributed the decline in TSMC's revenue and earnings to "the overall global economic conditions, which dampened the end market demand and led to customers' ongoing inventory adjustment."
TSMC saw a decline in sales of chips for smartphones, Internet of Things (IoT), and high-performance computing (HPC) applications during the quarter. The company's third-quarter guidance indicates that it is not out of the woods yet. TSMC expects $17.1 billion in the current quarter at the midpoint of its guidance range, which would be a 15% drop over the prior-year period. The Taiwan-based company projects a 10% decline in sales this year, which is worse than its prior expectation of a single-digit decline.
TSMC also warned that the production at its Arizona plant will be delayed to 2025. The plant was supposed to start production next year, but the lack of skilled labor hamstrung the company's plans. All this indicates that TSMC stock could remain under pressure in the near term.
A closer look at the company's business tells us that investors may want to take advantage of any pullback in TSMC stock as it is showing signs of benefiting from the growing adoption of AI. TSMC got 30% of its revenue from selling 5-nanometer (nm) chips last quarter, up from 21% in the year-ago period.
That's not surprising, as the company's 5nm chips are in great demand, especially from Nvidia, which is using the process node to manufacture its data center graphics cards for powering AI applications. TSMC is reportedly having to ramp up the output of its 5nm chips to fulfill additional orders from Nvidia. The advanced 5nm chips that TSMC manufactures for the likes of Nvidia are going to play an important role in the proliferation of AI. That's because chips manufactured on a smaller process node are more powerful and power-efficient at the same time.
And now, TSMC says that it will start ramping up the production of even smaller chips based on a 3nm process node from the fourth quarter of 2023. TSMC points out that it is already witnessing "robust demand" for its 3nm chips from both smartphone and data center customers. What's more, TSMC's roadmap tells us that it is working on a more advanced chip node dubbed N2, based on a 2nm manufacturing node.
The company expects its 2nm chips to go into volume production in 2025. These 2nm chips are expected to drive a 10% to 15% improvement in performance and a 23% to 30% reduction in power consumption as compared to the 3nm chips. As such, it won't be surprising to see Nvidia and other AI-focused chipmakers lining up to buy TSMC's upcoming offerings and boosting its top-line growth significantly over the next couple of years.
TSM Revenue Estimates for Current Fiscal Year data by YCharts.
Buying the stock is a no-brainer right now
The chart above tells us that TSMC's slowdown is likely to be temporary. Even better, management remains confident of achieving annual revenue growth between 15% and 20% over the next several years despite the challenging conditions it is facing in 2023. AI is going to be a cornerstone for this growth. According to TSMC CEO C.C. Wei:
Today, server AI processor demand, which we define as CPUs, GPUs, and AI accelerators that are performing, training, and influence functions accounts for approximately 6% of TSMC's total revenue. We forecasted this to grow at close to 50% CAGR in the next five years and increased low teens percent of our revenue.
Assuming TSMC clocks annual revenue growth of even 15% for the next five years, its top line could hit $135 billion in 2028 (using 2023's estimated revenue as the base). That would be double TSMC's projected revenue for 2023. The stock carries a five-year average price-to-sales ratio of 8.5. Multiplying that with its estimated revenue in 2028 would translate into a market cap of $1.15 trillion, which would be more than double TSMC's current market cap.
With TSMC stock currently trading at 7 times sales, which is a big discount to Nvidia's sales multiple, investors can consider accumulating this semiconductor stock for long-term gains as it could win big from a major catalyst in the form of AI.
