Artificial intelligence (AI) was the driving force behind many of the stock market's biggest winners in 2024. As big tech companies spend more and more on building out AI data centers and training large language models, several AI infrastructure companies are poised to continue benefiting throughout 2025.
While chip designers like Nvidia and Broadcom had stellar 2024s and could continue to do well in 2025, investors may want to look up the supply chain for an even better opportunity. Taiwan Semiconductor Manufacturing (TSM 5.25%) has seen its stock climb 113% since the start of 2024 as of this writing, but the most recent outlook for management suggests the stock has a lot higher to climb from here.
Image source: Getty Images.
An AI company investing in massive growth potential
TSMC had a lot of exciting news to share with investors when it reported its fourth-quarter earnings results earlier this month.
First of all, the fourth quarter was great for business. Revenue climbed 39% year over year and earnings per share soared 57%. Those profits were driven by better-than-expected gross profit margin, which touched 59%. The strong outperformance came as a result of high demand for its most advanced technology: its 3-nanometer and 5-nanometer processes.
TSMC's biggest advantage is its cutting-edge technology. Nvidia CEO Jensen Huang said TSMC is "the world's best by an incredible margin." That's why his company, along with Broadcom and a slew of other chip designers, all opt to use TSMC for their most advanced chips. And it's why TSMC is able to attract over 60% of all spending on chip manufacturing.
That massive market share ensures TSMC is able to stay ahead of the competition. With more revenue from customers, it can invest more in R&D and capital expenditures to improve its technological capabilities. In fact, TSMC expanded its market share in 2024 as a result of strong demand for advanced AI chips only it can produce.
The semiconductor manufacturing business requires massive capital expenditures ahead of demand to ensure there's enough capacity to meet demand. TSMC has historically done a good job of predicting demand and investing appropriately. To that end, management said it plans a big step up in capital expenditures in 2025. It's budgeting between $38 billion and $42 billion, compared to $29.8 billion in 2024.
That spending's supported by its long-term revenue growth outlook of 20% per year for the next five years. AI-related demand is playing a huge role in that outlook. Management expects AI accelerator revenue (which would include demand from Nvidia and Broadcom) to double in 2025 and increase at a mid-40% compound annual growth rate for the full five-year period in its forecast.
A bargain at its current price
The future looks very bright for TSMC, but the stock price might not fully reflect how much earnings growth is yet to come for the chip manufacturer.
In the immediate future, management expects mid-20% growth in revenue. While management called out several factors that could weigh on gross margin this year during its fourth-quarter earnings call, those should be offset by the ramp-up in production of 3nm chips. Indeed, analysts expect 28% growth in earnings per share for the year.
The stock trades for less than 25 times analysts' 2025 earnings estimates as of this writing, which is an incredible price for a company expected to grow earnings as fast as TSMC.
Earnings growth will likely come down in the future, although not by much. Management maintains its long-term gross margin forecast of 53%, about 5 percentage points below its first-quarter 2025 outlook. Operating margin might hold up a bit better thanks to scale, however, if management's 20% annual revenue growth forecast comes to fruition. The result should be earnings growth in the high teens through the rest of the decade.
There are several risks to consider, though. As a Taiwanese company, there are certainly geopolitical risks as tensions between the U.S. and China could curb its business. Investors should also consider the cyclicality of the business. Although TSMC has done a great job of planning its capital expenditures appropriately, outspending its growth could hamper its results in the near term. Over the long run, however, TSMC's position as the leading chip manufacturer is unlikely to change. That ensures it'll participate in the growth of AI and any new advancement in computing for the foreseeable future.
Even with those risks in mind, the stock looks like an absolute bargain at less than 25 times forward earnings.
