Today’s newsletter will be short and sweet, as the bulk of the content will be in my report for the new Bull List addition, Taiwan Semiconductor.
I have spent the better part of 3-4 weeks looking for a “picks and shovels” play in the AI space. With ASML, the other top-tier pick and shovel play already on the Bull List, I have to admit it was a tough task.
What caused me to add Taiwan Semiconductor to the Bull List was primarily the extremely impressive quarter it posted last week. The market’s reaction was fairly muted to the quarter, which I am not all that surprised with, considering it ran up quite a bit into earnings.
But despite a large surge in price here, I do see a path to further upside. Taiwan Semiconductor trades at large discounts to other Chip/AI plays, primarily due to geopolitical tensions between China and Taiwan. The true risk of these tensions is virtually impossible to quantify, which is why it is so hard to value the stock.
However, with projected earnings growth north of 25%+ annually for the foreseeable future, if it can hit those targets, I do believe there is still upside left here. I just believe the path there will likely be a bit rocky.
Of note, I do plan to buy this company at some point. Because I am 100% equity, it will likely come at the cost of one of my other US holdings. At this time, my sights move to Starbucks. However, a determining factor for Starbucks to stay inside my portfolio (and on the US Foundational List) will be a strong turnaround corner coming up at the end of October.
So, my decision will likely be made towards the end of the month.
Taiwan Semiconductor added to the Bull List
The core investment thesis here is that TSMC is the indispensable backbone of semiconductor production.
Some investors are buying TSM due to the bullish outlook regarding AI. And don’t get me wrong, it needs AI to continue advancing to justify its valuation. However, virtually every major technology trend (cloud computing, mobile connectivity, electric and autonomous vehicles, IoT, etc.) relies on more complex chips. TSMC is the primary manufacturer of the best of the best in this regard.
TSMC has some considerable competitive advantages: scale, technological lead, loyal customer base, and deep expertise. Ultimately, this is what creates their moat. And make no mistake about it, the moat is priced into the stock today. However, the company has showcased it can flex that moat at a substantial rate. This company has developed deep, trusted relationships with most of its top-end clients.
The company continues to invest heavily in future nodes (2nm, 1.4nm) and in expanding capacity globally. Because TSMC has such high margins and free cash flow generation, it can continually invest in new technology and advancements, all while putting next to no strain on the balance sheet. This is what forms most of the fortress around this company.
The pace of AI model scaling, large language models, and generative AI is relentless. Regardless of profitability on the end-user side of the spectrum, Taiwan Semiconductor gets paid for the production of the chips. As I mentioned above, it is a true “picks and shovels” play in the realm of artificial intelligence. The “picks and shovels” saying originates from the typical gold rushes, and the fact that the only companies to ever really make money over the long-term were those who sold the equipment for the miners to get the gold out of the ground. The miners, on the other hand, experienced numerous boom and bust cycles, and few of them were ever successful.
The company is in what I would call a constant feedback loop. The more successful TSMC becomes, the more it can reinvest in R&D, fabs, yield improvements, and recruiting top human talent. This creates a compounding edge: scale leads to better margins, more money becomes available for investments, which in turn leads to processing improvements, and ultimately, more customers. As this continues, TSMC pushes itself farther and farther ahead of major competitors.
Overall, the investment thesis is that TSMC’s role in the semiconductor ecosystem will translate into sustained revenue and earnings growth over the next decade, justifying its premium valuation. Yes, we might get some volatility if AI capex scales back. However, it is difficult to imagine a world without Taiwan Semiconductors at the forefront of a lot of up-and-coming technology. Thus, I believe it is worthy of its current valuations, despite it running up quite a bit over the last few years. Click here to read my whole report
