Taiwan Semiconductor Manufacturing (TSM +0.42%) is one of the world's most important companies. Its manufacturing and technological capabilities are greater than those of its competitors, which is why it makes chips for nearly every leading tech company globally. This is also why the U.S. is so invested in Taiwan maintaining the status quo of "two systems, one country," even as mainland China wants to take more control over Taiwan.
There are massive investing tailwinds behind the company, as there is a large demand for chips, notably in the artificial intelligence (AI) space. But where will TSMC (as it's commonly called) be in three years? After all, what it does over those years will define whether it can be a good investment.
Small chips are a big deal
One of the reasons Taiwan Semiconductor has solidified itself at the top of the chip industry is its culture of continuous improvement. Right now, TSMC is producing 3-nanometer chips. But it's also developing 2 nm chips, which it expects to have ready in late 2025 and produce with increasing quantity during 2026. Beyond that, it's working on a 1.4 nm chip although that likely won't be released within three years.
NYSE: TSM
Key Data Points
What Taiwan Semiconductor does over the next three years will largely be related to how the 2 nm chips fare and how strong the rest of its business remains in an environment where AI revenue is booming.
Back in Q2 2023, management boldly predicted that AI-related revenue would increase at a 50% compound annual growth rate for the next five years until it reached a percentage of revenue in the low teens. However, management severely underestimated the demand for AI-related chips; now it expects AI revenue to make up a midteens percentage of revenue in 2024 thanks to AI revenue tripling year over year.
This is a massive tailwind, and considering that many of the biggest cloud service providers (or hyperscalers) are planning to spend more on AI infrastructure in 2025, it's a huge benefit to TSMC in the near term. And its 2 nm chip will be a massive boost beyond that point.
A prediction of strong growth
One of the largest expenses in running these AI models is the energy consumed by the data center. One of the most popular graphics processing units (GPUs), Nvidia's H100, consumes about the same power a typical American household uses in a year. Considering that thousands of these GPUs are used in a server together, running these devices can be very expensive.
But what if Nvidia could make them far more energy-efficient?
That's what TSMC's 2 nm chip promises, as management states that these chips consume 25% to 30% less power than 3 nm chips when configured to run at the same speed. That's a massive cost savings, enough by itself to make companies upgrade their GPUs. TSMC is already seeing demand that outpaces the demand 3 nm and 5 nm chips saw at this stage.
This could be a huge revenue driver for the company as the chip reaches full-scale production in 2026. This is well within our three-year window, and TSMC will largely benefit from this new technology.
So where will TSMC be in three years? I'd say it will be in a far better place than it is now. Management projects revenue will grow by about 30% year over year for 2024, and Wall Street analysts expect 25% growth in 2025. Throw in the growth lever of 2 nm chips in 2026, and you have a company that is likely going to grow revenue at about the 20% mark for some time. That will drive greater earnings growth, which will bring Taiwan Semi's valuation down.
TSM PE Ratio (Forward 1y) data by YCharts
However, the stock doesn't trade at such a high valuation right now. At nearly 22 times 2025 earnings, TSMC isn't the world's most expensive stock, but it's not exactly cheap. However, considering how important the company is to the chip industry, I'd say it's a fair price to pay.
With Taiwan Semicondcutor's revenue expected to grow rapidly over the next few years, I'm confident that it won't just beat the stock market in terms of performance but will blow it away. The advancements in technology and business performance over the next three years should enable that prediction to come true.
