TSMC: Stock to Avoid or Incredible Buying Opportunity? (NYSE: TSM)

On Thursday, Taiwan Semiconductor Manufacturing (NYSE: TSM), better known as TSMC, released second-quarter earnings that blew away expectations. But management also noted it plans to increase its capital spending amid growing demand for advanced semiconductors. That includes another $100 billion commitment to build new facilities in Arizona on top of its existing plans to spend $165 billion in the U.S.

It seems the market is wary of that increased capital spending -- it sent shares lower on the news. But the sell-off the stock has been undergoing this month could be a buying opportunity for investors.

Image source: Taiwan Semiconductor Manufacturing.

TSMC's insurmountable lead

Management was relatively vague about its $100 billion commitment to build additional facilities in the U.S., but it was clear in its plans to ramp up total production capacity in the second half of 2026 and beyond. Management said it now expects capital expenditures for the year between $60 billion and $64 billion, up from its previous outlook of $52 billion to $56 billion.

Investors are concerned, though, as it's not clear how durable the growth in demand for TSMC's leading-edge chips for AI data centers will be in the long term. Its high-performance computing segment -- which is mostly comprised of AI chips -- accounted for two-thirds of TSMC's revenue last quarter, and it was the fastest-growing end market for the chipmaker as well.

But several factors should provide confidence in TSMC's ability to deliver strong returns on its invested capital. In the near term, management expects revenue growth to accelerate, forecasting full-year revenue growth of more than 40%. That growth comes with extremely high margins for the business. Its gross margin was 67.7% last quarter, and its operating margin reached 60.3%, year-over-year improvements of 9.1 percentage points and 10.7 percentage points, respectively.

What's more, TSMC's technological lead in producing cutting-edge chips with low defect rates at scale gives it significant pricing power. It used that power to raise prices at the start of the year, and did so again last month. Combined with continued improvements in the profitability of its 3-nanometer process node, it should produce strong margin expansion. That will be offset by the ramp-up of its new 2-nanometer process, which is running ahead of schedule.

In the long run, long lead times and TSMC's technological advantages mean it can build new capacity with greater confidence that it will have customers for it. While it's still subject to cyclicality, like all semiconductor manufacturers, its massive size and technological leadership mitigate the risks involved. Chip designers would be more likely to drop their foundry deals with smaller and less capable manufacturers rather than reduce their business with TSMC.

With the combination of strong revenue growth (40% this year, and the expectation of 20% or more in years to come) and margin expansion stemming from its pricing power, TSMC is poised to generate strong earnings growth even with a step-up in depreciation expenses. Trading at just 25 times earnings, the stock is an incredible buying opportunity right now.

Adam Levy has positions in Taiwan Semiconductor Manufacturing. The Motley Fool has positions in and recommends Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.