Why is TSMC valuation much lower than US peers?

TSMC valuation

TSMC discussion in my books

I have discussed the company Nvidia (ticker:NVDA) in two recent books; including:

In my book “The Rules of Super Growth Stocks Investing“:

  • Sections 2-4, the entire section is dedicated to introducing the company TSMC
  • Section 3-3, analyze the business development of technology companies to grasp the pulse of key industries

In my book “The Rules of 10 Baggers“:

  • Section 3-2, the entire section is dedicated to introducing TSMC and the global semiconductor supply chain.

Why I have this post

I often receive complaints about TSMC valuation from many investment friends that TSMC (ticker: TSM) is a stagnant stock and why the stock price performance of US technology stocks and TSMC’s peers in the Philadelphia Semiconductor Index is much better than that of TSMC. In fact, this perception is not entirely correct. TSMC’s stock price is not stagnant. Compared with many Taiwanese stocks, its performance is much better.

But human nature is always like this. You always feel that the stocks you hold rise too little and too slowly. Just like the CEOs of all listed companies always complain that the company’s stock price is undervalued, I remember that only Tesla’s Musk publicly complained in May 2020 that the stock price of Tesla (ticker: TSLA) was too high.

Since I published two books and wrote a blog for nearly three years, I have been constantly receiving the same question, even asking what is the reasonable price of TSMC (actually, this question is asking about: how much is TSMC DCF value)? So I simply wrote this article with my opinions to clear up the doubts of many investors.

TSMC’s DCF intrinsic value

I know that everyone is very interested in TSMC’s DCF intrinsic value, so I had a post a few days ago “What’s TSMC DCF intrinsic value?”, details how to use the “DCF (Discounted Cash Flow) Calculator” to calculate TSMC’s DCF intrinsic value.

The reasons why TSMC’s valuation is so low

Not a U.S. company

Few people pay attention to why the price earnings of TSMC stocks are lower than those of peers. I personally have always believed that the valuation of TSMC stocks is very similar to that of Chinese concept stocks (please refer to my post two years ago “The biggest risk to hold Chinese stocks, taking Alibaba and Tencent as examples“), the valuation of Chinese concept stocks is much lower than that of their American counterparts.

Because TSMC is not an American company, this is a matter of identity and lineage. This is a secret that cannot be told in the US stock market, but it is a fact. Smart investors, please think carefully about my opinion, and many questions about TSMC’s valuation will suddenly become clear.

Geopolitics

As I stated in my post “Is Buffett no longer hold for long haul? TSMC, HP, and US Bancorp cases study“, this is the reason why Buffett disclosed that he sold out TSMC stocks, and the content will not be repeated here.

No one wants to invest in companies in areas with high risk of war.

The fate of manufacturing

Difficult to maintain high growth

I emphasized in my two posts “Valuation methods significant different between US and Taiwan investors” and “Taiwan vs US stock market – For Taiwanese stock investors investing in US stocks” that the valuation of U.S. stocks mainly depends on the revenue growth of listed companies. This is The biggest difference between Taiwan stocks and US stocks.

It is not easy for the manufacturing industry to maintain high growth for a long time, that is, a high growth rate of revenue, especially when it takes at least three years to build a wafer factory that can easily cost tens of billions of dollars. When it comes to energy production and making money, it takes three years, and this is still the most Best situation.

The semiconductor industry generally goes through a boom cycle every four to five years. At the peak, when a large number of orders are received, the factory is expanded. The timing is not right, the boom does not recover as expected, and the capacity utilization rate of the built factory may be too low. You will lose a lot of money.

Moreover, the manufacturing industry usually attracts investment from parties with huge capital, who competes with each other to see who has the deepest pockets. After a long time, it will inevitably fall into a money-burning competition. It is not easy to maintain a sustained good situation for a long time.

Free cash flow is too low

Not only does Wall Street dislike listed companies in the manufacturing industry, but Buffett has repeatedly said that the manufacturing industry is not a good investment target-because the manufacturing industry must continue to invest in capital expenditures every year to maintain competitiveness, but capital expenditures eat up free cash flow, it’s the main culprit.

So why is TSMC’s free cash flow so low? Because TSMC’s operating free cash is actually very high, it earns a lot of money every day. However, TSMC’s capital expenditures are US$30 to 40 billion every year.

TSMC’s annual capital expenditures for 2023 announced in July this year are US$32 billion. This is a large number. There are few listed companies on the US stock market that are higher than this number. Rival Intel, in the same period in 2023 is US$32-36 billion. It which requires depreciation and amortization of expensive machinery and equipment every year, using up all the operating free cash flow earned.

Please note: Most Taiwanese investors always naively believe that TSMC has nearly 3 billion in free cash flow every year, which is an astronomical figure when converted into Taiwan dollars. But compared with TSMC’s market capitalization, or compared with TSMC’s U.S. stock market peers (please note that these two are important comparison indicators of valuation), the free cash flow is very low.

The impact of ADR

  • The ADR of 1 US share of TSMC is equal to 5 common shares of Taiwanese shares.
  • When most of the stock market is calm, the quoted price of TSMC’s U.S. depositary receipts (ADRs) will maintain a 10% premium compared to Taiwan stocks. If the market is bullish or favorable for semiconductor stocks, it may even be as high as 30%.
  • The rise and fall of TSMC’s US stock ADR almost determines the stock price trend of Taiwan Semiconductor Manufacturing Co., Ltd. on the next day, with few exceptions.
  • According to TSMC’s 2022 annual report, the special depositary receipt (ADR) account has a shareholding ratio of 20.52%, which means that Citi is responsible for the transfer, custody and liquidation of TSMC’s shares issued in the US stock market.

Non-Taiwanese Foreigners’ Institution Dominate

Perhaps you may think that TSMC’s U.S. stock ADRs only account for about 1/5 of TSMC’s outstanding shares in the U.S. stock market. The rise and fall of TSMC’s U.S. stock ADRs determines that the stock price trend of Taiwan Semiconductor Manufacturing Co., Ltd. is unreasonable.

But have investors ever thought about it: If foreign investors want to buy TSMC in large quantities, they will not buy TSMC US stock ADRs in the United States, but will buy in Taiwan stocks; this will of course determine the stock price trend of Taiwan Semiconductor Manufacturing Company.

Foreign capital is mainly from the United States. When large-scale investment institutions in the United States consider the valuation of TSMC, they use the perspective and starting point of the United States to compare TSMC with its local semiconductor peers in the United States, rather than taking Taiwan stocks as the main consideration. This is very important.

Why not convert Taiwan stocks into ADRs?

ADRs have historically traded at a premium because they are freely convertible, whereas stocks in Taiwan require special regulatory approval to be converted into their U.S. equivalents. This is not something that ordinary people can do, so it increases the incentive for arbitrageurs to earn the price difference. Fundamental Differences Between Taiwan and U.S. Stocks

The fundamental differences between Taiwan stocks and US stocks

The rise and fall of Taiwanese stocks is already small. In addition, Taiwanese stocks still have a limit of up to 10% on the rise and fall of individual stocks. US stocks do not have this limit, so the rise and fall of TSMC (especially Taiwanese stocks) will be gentler.

These restrictions have pros and cons, which is the main reason why the ADR of TSMC’s U.S. stocks will remain 10% higher than that of Taiwan stocks. In addition, the increase in TSMC radio stocks is usually smaller than the ADR of TSMC U.S. stocks the night before. The advantage is that if the ADR of TSMC U.S. stocks falls sharply the night before, the decline of TSMC radio stocks the next day will usually be much smaller.

I am the author of the original text, the essence of this story was originally featured on Smart Magazine

TSMC valuation
credit:wiki

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