Artificial intelligence (AI) has been around for a while, but it gained mainstream popularity in early 2023 due to the rise of generative AI tools like OpenAI's ChatGPT and Alphabet's Google Gemini.
Plenty of tech stocks have seen their valuations skyrocket because of the AI boom, but the biggest beneficiary has undoubtedly been Nvidia (NVDA 1.28%). Over the past three years, its stock has increased by nearly 920%, while the S&P 500 has risen around 64% over the same period.
Nvidia has gotten a lot of attention, and rightfully so. Its graphics processing units (GPUs) and AI software are very important to the AI ecosystem. However, there's another company that Nvidia relies on heavily that's just as important, and it's a stock I'm loading up on: Taiwan Semiconductor Manufacturing Company (TSM 0.75%) (TSMC).
TSMC's role in the AI pipeline
At first glance, calling a manufacturing company like TSMC an AI stock might seem unusual, but it's a pivotal player in how the technology all comes together. Let's take a look at how its business works.
TSMC is the world's largest semiconductor (chip) manufacturer and the pioneer of the foundry business model. You can't buy TSMC chips in a store or online like a smartphone or laptop. Instead, companies go to TSMC with their chip designs, and it manufactures them, bringing those designs to life.
For example, it makes chips for Apple's iPhones, Tesla's self-driving technology, AMD's processors, Nvidia's GPUs, and plenty of other applications. TSMC's relationship with Nvidia and other AI-chip designers is why I'm willing to consider it an "AI stock," even as a chip manufacturing company.
In fact, TSMC manufactures the vast majority of all high-performance AI chips, so there's a strong case to be made that without the company and its capabilities, the AI landscape would look significantly different -- for the worse.
Money coming in to back up the hype
The increased demand for AI chips is showing up in TSMC's financials. In the first quarter, its revenue increased 35% year over year to $25.5 billion. It expects its Q2 revenue to come in between $28.4 billion and $29.2 billion, representing year-over-year growth of 36% to 40%. That's impressive for a company of TSMC's size.
Data by YCharts.
Just three years ago, in Q1 2022, smartphone chips accounted for 40% of TSMC's revenue, while high-performance chips (HPCs), which include AI chips, accounted for 41%. Fast-forward to Q1 this year, and HPCs accounted for 59% of revenue, while smartphones accounted for only 28%. This shift in the composition of the company's top line isn't showing any signs of slowing down.
Play the long game
One of the risks facing TSMC's business is the geopolitical tension between Taiwan and China. However, management is working to address this concern by expanding its operations globally. TSMC currently has (or will have soon) manufacturing plants in the U.S., Germany, and Japan. This can help reduce some of its geographical risk.
There's a reason so many of the world's top companies rely heavily on TSMC -- it's the best at what it does. Having the most technologically advanced foundries and a large customer base that often signs long-term contracts puts TSMC in a position to have consistent and reliable growth for quite some time.
Trading at 28.9 times trailing earnings as of this writing, TSMC stock isn't "cheap" by most standards, but it's less expensive than other well-known AI stocks like Nvidia and Broadcom. And in this case, it's worth paying the slight premium for this undisputed industry leader, especially if you're looking for a long-term buy-and-hold position.
