When you factor in reinvested distributions, Taiwan Semiconductor Mfg. Co. Ltd. (NYSE:TSM) has been a three-bagger during the eight years I've held shares in my portfolio. The S&P 500 is up around 57% during the same period.
Yet, I won't sell. In fact, I expect to once again reinvest the annual distribution when it's paid at the end of the month. And I'll probably do it again next year, and the year following, and on until retirement.
Not because of Apple (NASDAQ:AAPL), though that relationship is important. The Wall Street Journal cites sources who say the Mac maker could be responsible for as much as 10% of Taiwan Semi's current-year sales. For perspective, analysts are expecting TSMC to generate $23.56 billion in 2014 revenue, a 17.2% year-over-year boost. Apple would be responsible for much of that gain.
Yet, that growth won't come cheap or easily given Apple's history with suppliers. Consider Foxconn, which may as well be an Apple subsidiary. The contract manufacturer has invested in 10,000 robots to build new mobile devices, yet it's Apple that gets first crack at the line. CEO Tim Cook will expect equally big investments from Taiwan Semi.
According to the Journal, TSMC has already sent a large team to Cupertino to better understand Apple's needs while also testing a new 16-nanometer process for making smaller and more power-efficient chips for future iDevices. Watch for large, cash flow-siphoning R&D and capital outlays as these investments begin to take hold.
If the Apple relationship isn't a good enough reason to buy, why should you or I be interested in Taiwan Semiconductor at current prices? I've three reasons for staying invested:
1. The overall market for advanced devices is exploding. More than 1 billion smart devices shipped last year, Gartner says. Yet, that's the tip of the iceberg. Morgan Stanley estimates that, by 2020, we'll see 75 billion devices connected to the Internet, and all of them will need chips. Taiwan Semi, which controls about half of the contract chip manufacturing market, will be responsible for an outsized share.
2. Most device makers don't manufacture their own chips. While I don't have perfect numbers for the the contract chip manufacturing market, most outlets size it at $39.3 billion. In 2010, Gartner put the total at $28.3 billion. Three years of 11.6% annualized growth can't be an anomaly. More companies are looking to vendors to produce the brains of their most advanced devices.
3. TSMC has a long-term track record. Revenue is up 12.4% annually during the past five years. Earnings and cash from operations have improved 12.8% and 9.4% a year, respectively, during the same period. Gross margin has held firm at north of 40%. Intensifying competition from the likes of Intel and Samsung has done nothing to sour this sweet story.
Mix in an annual distribution that yields 1.90% for ADR owners, and I think you've the making for one of the market's best chip stocks right now.