Better Buy: Advanced Micro Devices vs. TSMC Stock

The artificial intelligence (AI) frenzy is driving many tech stocks sky-high this year. The closer a company is to the epicenter of the machine-learning trend, the faster its stock soars. For example, Advanced Micro Devices (AMD 2.37%) designs microchips for the specific purpose of running AI analyses. Taiwan Semiconductor Manufacturing (TSM 1.26%) manufactures most of AMD's chips. Taiwan Semi's stock is up 26% so far this year. AMD's has gained 63%.

But past performance is no guarantee of future results. The burning question on every semiconductor investor's mind is whether AMD or Taiwan Semi (also known as TSMC) is the better investment right now.

So let's figure it out.

The case for Taiwan Semi

These businesses couldn't be more different, but they also can't be much more alike. AMD designs microchips, both for general computing use and for very specific purposes such as AI analysis or processing digital graphics. TSMC develops cutting-edge chip-making techniques and puts them to use by converting its clients' blueprints into physical products. It should be noted that AMD used to run its own manufacturing plants, but spun that part of its operation off to form TSMC rival GlobalFoundries in 2009.

At first glance, TSMC might look like a superior semiconductor investment. The stock is not skyrocketing in 2023, so you can buy it today without feeling like you've already missed the train. The stock is also far more affordable as measured by several key metrics.

Data collected from Morningstar on Aug. 31, 2023. EBIT = earnings before interest and taxes.

Their price-to-sales ratios are fairly close, but then AMD takes home a much larger slice of its incoming revenue stream. Still, AMD generates much lower profits and cash flows despite its wider gross margins. Therefore, this outlier only underscores how much more efficient TSMC's business model is in terms of converting top-line sales into take-home profits.

And the profit-based valuation figures all reflect the same blowout in valuation terms. AMD stock is flying dangerously close to the sun, while Taiwan Semi keeps crawling steadily forward on solid ground. A small setback could send AMD's stock through the floor. TSMC is not as vulnerable to execution risks. Slam-dunk, hole in one, touchdown -- Taiwan Semi must be a better investment than AMD. Right?

The case for AMD

But that's not the whole story. Here are three key reasons why you might want to pick up AMD shares in September.

• AMD's business is cyclical, ebbing and flowing with the release of new microarchitectures for its CPU and GPU product lines. The Zen 4 CPU architecture came out in September 2022 and is already getting old. The Zen 5, which takes advantage of a more efficient manufacturing platform from TSMC, is slated for release next spring. With higher performance, lower power consumption, and more processors per silicon wafer, these generational shifts bring many benefits to AMD's business results. So next year should deliver a cyclical upswing in AMD's Ryzen and EPYC CPU sales.
• The company has offered high-performance processors for the data analytics and AI markets since 2016. Its Radeon Instinct cards are often found in high-end supercomputers. They offer features and performance comparable to Nvidia's (NVDA 6.18%) A100/V100 products. This is another cyclical market, and AMD's most recent high-performance cards aren't even using the company's latest and greatest Radeon CDNA 3 architecture yet. AMD's engineers are burning the midnight oil to bring a bleeding-edge AI card to market in time to strike while the iron is hot. The Instinct MI300 AI accelerators should hit store shelves later this year.
• AMD's big-ticket buyout of reprogrammable hardware expert Xilinx closed in February. That deal brought in expertise, technologies, and successful product lines from an established leader in embedded computing. AMD CEO Lisa Su wouldn't spend $50 billion on a whim, and I can't wait to see what the combined company can do. Xilinx solutions should start popping up across AMD's product portfolio in the coming years, with potentially game-changing financial results.

So AMD is a direct bet on the explosive AI surge, and we can expect that bet to be sweetened by a cyclical upswing in the PC and data center CPUs next year. If AMD's stock leaves you with a bit of sticker shock, it's still a steal compared to Nvidia, which trades at 39 times sales. This growth stock may have a very different investment thesis than TSMC's more value-oriented buy-in thesis, but it is no less interesting.

The winner in my book: Taiwan Semiconductor

I see why AI investors might want to jump on the AMD bandwagon right about now. The company's prospective AI business is not far behind Nvidia's, and its stock is much less expensive than the early AI-processor leader's. Also, I've said this before and I'll say it again: CEO Lisa Su has earned a truckload of respect by taking this business from the brink of bankruptcy to the industry-leading position it holds today. Die-hard growth investors should probably choose AMD over TSMC today.

Yet, I can't help admiring TSMC's bargain-bin stock valuation. I would be buying this stock hand over fist right now if the company didn't carry the geopolitical risk of having most of its operations in Taiwan. Still, TSMC could be worth the risk of a modest investment. A thoughtful strategy like buying in thirds may be the ticket to managing those risks without missing out on a compelling opportunity.