Not Intel. Not Nvidia. The $2.4 Trillion Chipmaker That Wall Street Calls the Ultimate AI "Picks-and-Shovels" Play

By now, everyone and their mother knows computer chips are the key to the artifical intelligence (AI) boom. No chips, no training of advanced AI, or running them on billions of computers worldwide. This has brought Intel back from the dead and made Nvidia the most valuable company in the world by market cap.

There are plenty of underfollowed gems in the computer chip sector, many of which are not well known to the general public. One is the backbone of the entire advanced computer chip manufacturing, powering AI training. The company's name is Taiwan Semiconductor Manufacturing (NYSE: TSM), or just TSMC for short.

Here's why the $2.4 trillion market-cap stock is the ultimate pick-and-shovel play for the AI revolution.

Nvidia's supplier and dominant leader in chipmaking

Most of the largest technology companies in the world contract with TSMC for chipmaking. Nvidia does not manufacture its own chips; it instead sends its designs to TSMC, the only company in the world that can produce them at scale. Even Intel has been forced to outsource some of its advanced chipmaking to TSMC.

Hyperscalers use TSMC for contract manufacturing of their own computer chips used in AI cloud computing. Most of Apple's computer chips are made by TSMC.

This has made TSMC an integral part of not only the AI revolution but also the growth of smartphones and general cloud computing. Revenue was $143 billion during the past 12 months and rose 34% year-over-year last quarter. The company is seeing booming demand from its high performance compute (HPC) segment, which increased 20% quarter-over-quarter and now makes up 66% of the overall business.

Image source: Getty Images.

Fantastic economics and geographical diversification

Where TSMC shines is its profitability. Unlike most manufacturers, TSMC has immense pricing power because it is the sole company capable of making these chips for the likes of Nvidia and Apple.

Operating margin was 60% last quarter, which is higher than almost every software company in the world. Apply that to its trailing revenue, and total profit would be $86 billion.

Some investors worry that TSMC is tied to Taiwan, which is risky given China's rhetoric about invading the island nation. The company is working quickly to diversify its manufacturing operations into the U.S. and other countries, with a plan to invest $265 billion in U.S. factories alone. Much of this construction is already complete.

TSM PE Ratio data by YCharts

Is TSMC stock a buy?

TSMC's surge in revenue and profit driven by AI may not be replicated in the years ahead. That could amount to a speed bump in revenue growth if the likes of OpenAI, Anthropic, and others stop investing enormous amounts of money in AI training and usage.

With a trailing price-to-earnings ratio (P/E) of 33, TSMC stock does not look overly expensive compared to its trailing growth rate. The shares will probably climb higher if demand for AI computer chips continues in the years ahead.

Investors need to exercise caution if the AI boom eventually slows or busts. This would not only hurt TSMC's revenue but also likely its profit margins, which are higher than normal. For example, if TSMC's annual revenue increases to $200 billion and it maintains a 60% margin, that is $120 billion in earnings and would likely lead to a higher stock price.

However, if revenue falls to $125 billion in a slowdown and margins go down to 45% or lower, earnings would fall to $56 billion, which is a huge difference -- and would likely lead to a lower stock price.

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