Huge news for investors in this artificial intelligence (AI) stock

It’s TSMC’s world; the rest of us just live in it. 2024 is shaping up to be a positive year for Taiwan Semiconductor Manufacturing(NYSE: TSM)the leading manufacturer of advanced semiconductors around the world.

The company has embarked on a major expansion outside its home market of Taiwan due to geopolitical concerns with China, prompting it to invest billions in factories in Arizona. Last week, the company announced a major milestone with these new US factories.

Here’s why TSMC’s latest update is important for the business going forward, and what it could mean for the stock over the long term.

Chip yield and why they matter

TSMC’s Arizona factory is being readied for commercial production in 2025. As it ramps up the facility, the company is testing the yield of the semiconductor wafers pumped out of its manufacturing process. These wafers are then turned into advanced computer chips, making them vital to companies such as Apple or Nvidia and the artificial intelligence (AI) revolution. The higher the yield, the more of each wafer works in the manufacturing process. Basically, it’s a measure of how much of each wafer is working properly.

Last week, TSMC reported that it achieved 4% higher yields at its Arizona facility compared to its factories in Taiwan. This is huge news for the company. Why? Investors and analysts doubted that TSMC’s factories would be as successful outside Taiwan, which has been the beating heart of the semiconductor market for ages. Advanced manufacturing semiconductors is no easy feat, requiring teams of scientists, engineers, advanced technologies and institutional know-how built up over decades.

Now TSMC has allayed fears that this process could not be repeated in the US. Higher yields mean TSMC can sell more semiconductors per share. unit of production while costs remain the same. In other words, it should lead to higher profits, all other things being equal. If TSMC was unable to replicate its Taiwan operations in Arizona, there was a risk that its profit margins would drop significantly as all these new facilities began to come online. This fear is now being put to bed.

AI demand is not slowing down

These Arizona facilities — along with others in Japan and Europe — will be important to the artificial intelligence market over the next five to 10 years. TSMC may be the only company currently capable of building the most advanced semiconductors in the world for companies like Nvidia, which is the key supplier of all the data center spending associated with the AI ​​boom.

In simpler terms, as AI spending grows, so does TSMC’s revenue. All these new factories should help the company keep up with customer demand, which looks insatiable. For example, last quarter TSMC’s high-performance compute (HPC) segment grew 11% quarter-over-quarter and now accounts for 51% of total sales. Just two years ago, in the same quarter, the HPC segment was only 39% of total sales. HPC uses advanced semiconductors for data centers, which means AI.

Investors should follow the HPC segment closely, as it now accounts for the majority of TSMC’s consolidated revenue and is growing like wildfire. If spending on data centers and artificial intelligence continues to boom, TSMC’s revenue will likely continue to grow at a rapid clip. With wafer yields close to the same levels as in Taiwan, profit margins should also remain high. Last quarter, the operating margin was a robust 47.5%, showing just how valuable TSMC’s high-end computing products have become.

ASML PE ratio data of YCharts

Rising earnings mean high expectations

With these booming sales and profits, TSMC’s stock has started to rise. In the past year alone, shares have risen over 100% and briefly traded at a market cap of over $1 trillion.

These gains have brought the stock’s price-to-earnings (P/E) ratio to 31, which is a premium valuation and slightly higher than S&P 500 index average. Some investors would turn away from TSMC stock because of its high P/E. However, I think this is missing the forest through the trees. Yes, TSMC has a high P/E, but it has proven over the long term that it can grow earnings at a rapid clip and has a big tailwind in the form of AI spending. In the last 10 years, the company’s earnings perEPS) has grown cumulatively by close to 300%.

Despite this high valuation, I think TSMC stock is a buy at these prices if you’re a long-term supporter of AI. One of the best companies in the world continues to extend its lead and is now showing that it can replicate its manufacturing process in other geographies.

Don’t miss this second chance for a potentially lucrative opportunity

Have you ever felt like you missed the boat on buying the most successful stocks? Then you want to hear this.

On rare occasions, our expert team of analysts issue a “Double Down” stock recommendation to companies that they believe are emerging. If you’re worried that you’ve already missed your chance to invest, now is the best time to buy before it’s too late. And the numbers speak for themselves:

• Amazon: if you invested $1,000 when we doubled in 2010, you would have $22,292!*
• Apple: if you invested $1,000 when we doubled in 2008, you would have $42,169!*
• Netflix: if you invested $1,000 when we doubled in 2004, you would have $407,758!*

Right now we are issuing “Double Down” alerts for three incredible companies, and there may not be another chance like this anytime soon.

See 3 “Double Down” stocks »

*Stock Advisor returns on October 28, 2024

Brett Schafer has no position in any of the shares mentioned. The Motley Fool has positions in and recommends Apple, Nvidia and Taiwan Semiconductor Manufacturing. The Motley Fool has one disclosure policy.