With the U.S.-China trade settlement talks at advanced stages, investors are starting to look at Asian companies listed on U.S. exchanges as potential investment options.
One of the most interesting sub-sectors within the technology space which could witness excellent growth over the coming years is the semiconductor space. As per Morningstar data, semiconductor stocks have been growing at an annualized rate of more than 24% in the past three years. This growth is expected to continue with the advent of 5G and the growth of the Internet of Things (IoT) industry, along with various other factors leading to a higher demand for chips and semiconductors.
Taking this into account, it is important for growth investors to find promising semiconductor stocks for a long-term horizon. A good example of one such stock with a strong track record and a solid upside potential is Taiwan Semiconductor Manufacturing Co Ltd (TSM, Financial)
What does Taiwan Semiconductor do?
Founded in 1987, Taiwan Semiconductor’s core business is the production and sale of integrated circuits and semiconductor devices, masks and packaging technology services. Based in HsinChu, Taiwan, the company deals heavily in peripherals, wired and wireless communication systems, information applications and so on. The end-market for Taiwan Semiconductor’s products is not just IT companies but also industrials, consumer electronics, digital TVs, game consoles and digital cameras. The company also has a strong involvement in the renewable energy space and manufactures energy-saving products and technologies. It has a wide distribution network across the U.S., Middle East, Asia-Pacific, Africa and Europe.
A consistent outperformer
Taiwan Semiconductor has long been an outperforming stock with a continuous growth trajectory for the past five years. It has more than doubled in value in the past three years and its appreciation in 2019 alone was more than 60%.
The company delivered its most recently quarterly result last week. This was the second quarter in a row when management delivered an outperformance on the revenue as well as the earnings front. The company reported a top line of $10.6 billion, which was about $100 million above analyst expectations, largely driven by growth in its 7-nanometre technology as well as the advanced technology (16-nanometre) growth. Smartphone-based revenue continued to dominate with around 53% of sales. In terms of the earnings per share, the company reported 75 cents, which was above the analyst consensus estimate of 73 cents. Through its operations, the management was able to generate $32.95 million of free cash.
A strong macro that will continue to fuel growth
When one analyses Taiwan Semiconductor from a macroeconomic perspective, there is immense potential growth resulting from all the major sectors that it caters to, whether it be telecom, IoT or even renewables.
A number of tailwinds could benefit the company in the coming year, one of which is 5G technology. Companies like Taiwan Semiconductor, which are focused on the manufacture of chips and semiconductors, are bound to benefit from new technologies coming up within the communications space. Its next-generation, ultrafast wireless technology results in faster data transfer and better cost savings for users, and it has the potential to not just to power cell phones but also the internet of cities and industries as a whole.
Apart from 5G, there is also the potential of the IoT market, which has finally seen some growth in mainstream business use. As per a report by McKinsey & Company from July 2019, the number of IoT devices is expected to be as high as 43 billion by 2023, about three times as much as the number from 2018. This would imply a huge market for Taiwan Semiconductor’s products.
Last but not the least, renewable energy solution requirements are also expected to grow at a double-digit rate, implying that the macro-economic scenario is completely in favor of the company.
Fundamental solidity
From the point of view of financial fundamentals, Taiwan Semiconductor is one of the most solid companies within the semiconductor space. Its revenue has been growing at the rate of 6.9% per annum on an average basis for the past three years, and it has witnessed a strong margin expansion as well. Its net margin of 32.72% is well above the industry average and results in a solid return on equity of 21.01%. If the management is able to cash in on the strong macro environment, the annualized top-line growth could be well into the double digits for the coming year. Taiwan semiconductor has a very clean balance sheet with the total debt accounting for around 8% of the equity value. Its price-earnings ratio is not too high at around 25.32.
However, the biggest highlighting point regarding its fundamentals is the amazing level of yield-on-cost. Taiwan Semiconductor has a dividend yield of 3.44% and its overall yield-on-cost is as high as 10.37%, which is way above industry peers. This number is phenomenal and it shows that the company can provide yield as well as capital appreciation, making it a strong investment proposition.
Key takeaways
After the trade war, it is natural for investors to be circumspect and over-cautious with respect to investments in Asian companies, but opportunities like Taiwan Semiconductor are hard to come by. The company has been an amazing growth story for the past five years and is backed by very strong macro-economic factors that could boost its future growth. Its financial fundamentals and yield are exceptionally good, and its valuation also does not appear too high. Overall, Taiwan Semiconductor could well be the only semiconductor stock you need in your portfolio for 2020.
Disclosure: No positions.
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