This article first appeared in The Telegraph magazine. Column Questor.
A successful long-term investment strategy has been to buy and hold shares of dominant, growing companies. These are rare beasts that can meet the needs of their customers better than anyone else and keep them that way.
They have what Warren Buffett calls an “economic moat” that keeps competitors at bay while maintaining high levels of profitability. Combine a moat with a strong growth market, and you have all the ingredients of a great investment—as long as you can buy the shares at the right price.
When it comes to semiconductor manufacturing, Taiwan Semiconductor Manufacturing Company (TW:2330), known as TSMC, has several hallmarks of a great company. Many of the world’s best portfolio managers recognize this as such.
Thirty-four of these investors, all of whom rank in the top 3% of the 10,000 stock fund managers tracked by Citywire, own TSMC stock. Supported by top-performing portfolio managers, the company has earned the highest AAA rating from Citywire Elite Companies.
Top Three Elite Sponsors
Sources: Citywire/Morningstar, latest asset data.
How Citywire Elite Companies Work
As a manufacturer and supplier of high performance microchips for AAA rated companies. Apple (USA: AAPL) and Nvidia (USA: NVDA) and rated A Advanced microdevices (US:AMD), TSMC dominates its markets and delivers exceptional returns to its shareholders. Its shares are up 46% over the past year and 715% over the past decade, eclipsing the earnings of former industry leader Intel.
TSMC’s dominance is based on leadership achieved through investments in advanced technologies and manufacturing processes. Combined with huge savings from investing in large manufacturing plants (known as “fabs”), the company offers the best chips at the lowest price.
This means that chip buyers without their own manufacturing facilities can begin developing their chips with confidence that TSMC will provide them with what they need. And because TSMC only makes chips for third parties, customers can rest assured that it won’t compete with them. Competitors such as Samsung Electronics and Intel make their own chips as well as third-party chips.
It is these bonds of trust that TSMC has built with its customers over the years that are perhaps its greatest competitive advantage. This largely explains why TSMC chips dominate the offerings of AI leaders like Nvidia and AMD.
TSMC’s prospects look very bright. The company’s products are well positioned to take advantage of the rapid growth of three megatrends: the ongoing deployment of 5G mobile networks, the rise of high-performance computing and the development of artificial intelligence.
The company is currently scaling up production of 3nm (nanometer) chips, with 2nm chips to follow in 2025. They offer the very high processing power and energy efficiency levels demanded by these three key markets.
Despite talk of increased competition, TSMC’s technology is still ahead of its competitors’ technology and offers its customers products that need to have a long shelf life.
After a difficult 2023, in which the semiconductor industry was hit by excess inventory and declining sales, 2024 is looking good. The recovery in demand is expected to be driven by high-performance computing and the continued growth of generative AI applications.
Recent first-quarter sales rose more than 16% and were better than investors expected. Even the recent earthquake in Taiwan hasn’t knocked the company off course, as it maintained its revenue growth forecast of more than 20% this year.
However, it is the potential political earthquake from a Chinese invasion of Taiwan that continues to unnerve some investors and keep them from buying TSMC shares. This threat is nothing new, and while fears may be justified to some extent, a Chinese invasion of Taiwan would also tear a hole in most global stock prices.
TSMC is diversifying its chip production and opening new factories in Japan, the US and Germany. They won’t be as cheap to build as those in Taiwan, but the company believes it can maintain a high return on investment as it scales up production.
It is also true that even with the advancement of artificial intelligence, TSMC will still be a cyclical business and will experience ups and downs in demand in the future.
However, with the company’s shares trading at 18 times projected earnings per share over the next 12 months and medium-term earnings growth of around 20%, many risks outweigh the price. Many elite investors are betting that the shares are too cheap for a dominant global leader in a rising market.
| Key Facts – TSMC | |||
|---|---|---|---|
| Market capitalization | NT$19.9 trillion | Price | TWD766 |
| 52 week high/low | NT$826 / NT$489 | Return on invested capital | 21.9% |
| Highest price per profit | 18.2 | First dividend yield | 1.8% |
| Fastest EPS Growth | 22.2% | share price for 12 months. | 53.8% |
Source: FactSet. EPS = earnings per share. Forecasts for the next 12 months.