1 Unstoppable Stock Powering Nvidia and the AI ​​Revolution

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Without this manufacturing giant, Nvidia would not exist in its current form.

Five minutes can't go by without hearing about you Nvidia These days. The computer chip giant recently became the world's largest company by market capitalization and is worth more than $3.34 trillion today. Investors are betting that big capital spending on artificial intelligence (AI) will continue, with Nvidia maintaining its dominant position in the market.

But which companies power Nvidia? There is one that rises above all the rest, and it is the backbone of advanced semiconductor manufacturing worldwide. enter Taiwan Semiconductor Manufacturing (TSM -1.40%)Nvidia and the company powering the AI ​​revolution.

Is the stock a buy? Let's take a closer look and find out.

Taiwan Semiconductor: The backbone for modern computing

Taiwan Semiconductor (TSMC for short) has risen above the pack in chipmaking thanks to its innovative foundry model. This means that TSMC does not sell the chips it makes directly to consumers — IntelThe old business model of — but collects orders from computer chip designers. This allows it to focus solely on manufacturing expertise and lead the way in the most advanced semiconductor manufacturing in the world.

It has few if any competitors such as Intel, Samsung, and native Chinese players. Users are included. apple, the alphabet, Amazon, and the aforementioned Nvidia. With new AI tools increasing demand for computing, companies have had to buy chips from players like Nvidia or design them themselves. Almost all outsource this production to TSMC.

With minimal competition and very high switching costs, the company has huge lock-in with customers and a ton of pricing power that allows it to make exorbitant profits. Over the past 1 year, operating income has grown nearly 300 percent and has reached $30 billion in the past 12 months. It generates just over $70 billion in revenue and saw revenue rise 30% in May as more orders came in to accelerate AI capital spending.

Investors Bet on AI and Geodiversity

TSMC stock is up 439% over the past five years and has hit multiple all-time highs in 2024. Investors are betting that the AI ​​revolution will continue to drive company growth over the next few years. Even so, anyone looking to buy the stock today should wonder if the market is getting a little overzealous with AI companies right now.

Some may see parallels to the dot-com bubble with AI stocks. Although the Internet has turned into one of the most important technologies of all time, that didn't stop overpriced stocks from dropping 90 percent when the bubble burst. Given its diversity across the entire semiconductor market, it's hard to see TSMC dropping 90%, but the threat of an AI bubble remains nonetheless.

Another potential tailwind for TSMC is geographic diversification. The company's manufacturing is focused on its home turf, which faces a growing threat of Chinese aggression. Obviously, this would be bad for shareholders.

To mitigate this risk, TSMC is working with countries like the US to build factories outside of Taiwan. It was recently awarded $6.6 billion by the US government and is building tens of billions of dollars worth of factories in the country. This will help reduce the threat of China's invasion and accelerate growth in the next decade.

TSM PE ratio data by YCharts.

But is the stock cheap?

Less than two years ago, TSMC traded at a price-to-earnings ratio (P/E). teens.

With stocks now climbing to all-time highs it's hard to make the same argument. This is not a hyper-growth business that can triple its revenue instantly. Yes, this is currently driving revenue growth due to AI spending, but it also comes with the risk of a bubble of new technologies. Let's not forget the China threat either.

gave S&P 500 Trades at a P/E of around 28. TSMC is well above that level, and it's not like the market is cheap either. Considering all these factors, TSMC stock does not look like a good stock to buy at these prices even though it is the backbone of the AI ​​revolution.

Suzanne Frey, an Alphabet executive, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, is a member of the board of directors of The Motley Fool, an Amazon subsidiary. Brett Shaffer has positions at Alphabet and Amazon. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 calls on Intel and short August 2024 $35 calls on Intel. The Motley Fool has a Disclosure Policy.

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