Taiwan Semiconductor Manufacturing Company (TSM) is currently the world’s largest specialized foundry in the semiconductor industry. TSM produces semiconductors based upon custom-designed integrated circuits that its customers request. It produced 24% of world’s total semiconductor (excluding memories) output value in 2020. This further strengthens the company’s industry-leading position.

TSM shares fell in the last few months despite continued growth. TSM shares should grow as global demand rises for semiconductors. This will allow investors to take advantage of TSM’s dips. The stock is a strong investment. TSM shares, while not cheap, come with a premium price. (See Taiwan Semiconductor Manufacturing stock charts on TipRanks)

Growing Semiconductor demand supports growing financials

The chip’s increasing popularity and incredible growth has seen the semiconductor industry grow tremendously year after year. In fact, semiconductors are becoming an essential part of almost any modern device. To function correctly, everything in computers, televisions, washing machines, refrigerators, etc., uses semiconductors.

While the demand for electronic devices is increasing and new trends such as Internet Of Things, self driving electric cars, VR and AR continue to increase, the semiconductor sector should enjoy favorable tailwinds.

TSM’s financial results should grow because of the rising demand for processing horsepower. TSM’s revenue and net income have a compound annual growth rate (CAGR) of 13.8% and 15.5% over three years. This means that TSM will likely continue to grow its top and bottom lines in double figures.

TSM Valuation

Although I am confident that TSM will continue to be a market leader, it is important for investors to pay attention the stock’s current valuation. TSM shares currently trade at a forward PE of 23.15. The multiple isn’t crazy high, but it is high in general when you consider the industry. It is not unusual to see stock prices in this industry trade in multiples of a single digit, as demand for semiconductors may be seasonal.

TSM’s leadership position in the market does merit a premium. However, TSM should be able withstand any short-term headwinds purely due to its size. Additionally, investors currently value the stock fairly if EPS growth keeps up its pace in the medium term. TSM, a high-quality company, has strong prospects. Investors should expect a moderate valuation multiple expansion in this low-rate environment.

A stock with a high premium multiple should be able to retain capital returns that are higher than its current level. Since its inception, the company has not reduced its dividend growth since 2004. Although the current yield is only 1.32%, it was a substantial increase. The DPS rose by 11.1%, and future increases will likely be north of 10%. This support comes from a 37.9% payout ratio.

Wall Street’s Take

Taiwan Semiconductor Manufacturing is rated Moderate Buy by Wall Street based upon one Buy in the last three months. At $138.00, the average Taiwan Semiconductor Manufacturing price target implies 23.70% upside potential.

Disclosure: As a stock owner, Nikolaos Sismanis owned shares in TSM and held a position that was long-term beneficial to him.

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