Semiconductor stocks have been in impressive form on the market over the past three years, as the demand for chips used for training and deploying artificial intelligence (AI) models in data centers has shot up remarkably during this period.
Not surprisingly, the PHLX Semiconductor Sector index's gains of 44% in the past three years have been higher than the 29% jump clocked by the tech-laden Nasdaq-100 Technology Sector index over the same period. Taiwan Semiconductor Manufacturing (TSM 1.25%), or TSMC, has been one of the big beneficiaries of the spurt in semiconductor spending, with its shares rising 69% in the past three years (as of this writing).
TSMC's solid rally has brought its market cap to $980 billion. The good part is that this semiconductor bellwether seems capable of delivering more upside in the long run as well, and it may even hit $2 trillion in market cap.
NYSE: TSM
Key Data Points
Let's look at the reasons why.
TSMC plays a critical role in the global semiconductor market
It is easy to see why TSMC stock has shot up. The company fabricates chips for all the major chip designers, including Nvidia and AMD. In fact, all the fabless chipmakers that have been designing AI chips are using TSMC's fabrication plants to produce their chips.
Consumer electronics companies such as Apple that are looking to offer AI solutions to their customers in their devices also tap TSMC to manufacture advanced processors. All this explains why the Taiwan-based foundry giant has seen a sharp uptick in its growth in the past year.
TSM Revenue (TTM) data by YCharts.
More importantly, TSMC's dominant 64% share of the global foundry market means that it is well-placed to make the most of the secular growth in the AI chip market over the long run. According to one estimate, the global AI chip market could reach an annual growth rate of almost 35% over the next decade. The market's impressive growth is expected to be powered by the penetration of AI into multiple industries ranging from healthcare to finance to automotive, among others.
As TSMC manufactures chips for the leading chip designers serving these industries, including the likes of Qualcomm and Broadcom, the company should ideally be able to sustain the healthy growth that it has been clocking in the past year. This is precisely what management pointed out on the company's January earnings conference call:
Underpinned by our technology leadership and broader customer base, we now forecast the revenue growth from AI accelerators to approach a mid-40% CAGR for the five-year period starting off the already higher base of 2024. We expect AI accelerator to be the strongest driver of our HPC platform growth and the largest contributor in terms of our overall incremental revenue growth in the next several years.
What's more, TSMC is anticipating its total revenue to increase at an annual rate of around 20% for the next five years. This could send TSMC's top line to almost $225 billion after five years from last year's figure of just over $90 billion. TSMC has a five-year average sales multiple of 9, and a similar multiple after five years could send its market cap to just over $2 trillion.
This stock is a no-brainer buy right now
The above scenario indicates that TSMC stock is capable of more than doubling in the next five years. However, it may be able to deliver more upside than that if the market decides to reward it with a richer valuation. It is worth noting that TSMC is currently trading at 11 times sales. So, the sales multiple we are assuming after five years means that it will trade at a discount at that time.
But it won't be surprising to see it trade at a premium at that time as well to its five-year average, especially considering that its share of the foundry market has been improving. More specifically, its foundry market share increased by three percentage points in the third quarter of 2024, compared to the prior-year period.
It may be able to further strengthen its position in this market. Samsung is the second-largest foundry in the world, with a much smaller share of 12%. TSMC is looking to extend the gap with Samsung, as the former is looking to move to a more advanced 2-nanometer (nm) manufacturing node. TSMC is expected to start producing 2nm chips for customers in the second half of 2025. This may give it a slight edge over Samsung, which may start 2nm production in the fourth quarter of the year.
More importantly, TSMC has reportedly planned improvements to make its 2nm technology better so that it can deliver higher computing performance and efficiency. As such, TSMC's grip over the global semiconductor market is likely to remain solid over the long run. Buying this stock right now looks like a no-brainer, as its earnings multiple of 27 is lower than the Nasdaq-100 index's multiple of 34 (using the index as a proxy for tech stocks).
