Taiwan Semiconductor Manufacturing Just Gave a Warning to Nvidia Investors

Taiwan Semiconductor Manufacturing (NYSE: TSM) (TSMC) just reported blockbuster earnings, and yet the stock fell after the report. The chip fabricator is fielding explosive demand, and it's investing in the build-out to meet it. However, the market is becoming more wary about high levels of spending on artificial intelligence (AI), which impacts Taiwan Semi from two sides -- its own deep spending and that of its clients.

Shares of the chip foundry fell 5% after the earnings report, and it sent chip stocks down across all markets. Here's why it's a warning for Nvidia (NASDAQ: NVDA) shareholders.

The market has seen this play out before

There are always cycles in the economy and the markets, although some are more extreme than others. Often, how a company rolls through a cycle determines whether or not it's a great stock to own.

Consider how companies built out to meet soaring demand early in the pandemic. Companies like Zoom Communications and Fiverr soared, since investors viewed them as critical components of the remote workforce. They peaked in 2020 and 2021, respectively, and are now 84% and 97% off their highs, respectively.

Nvidia workstations. Image source: Nvidia.

Companies like Amazon and Shopify also built too much, and their stocks fell. But they were able to roll back their spending, and both stocks recently reached new highs.

At the end of this cycle, whenever it is, the same pattern is likely to emerge; some companies are enjoying the current AI wave, but when it ends, so will growth, while others will rebound with new growth drivers.

Why the market is worried about TSMC

For all intents and purposes, TSMC had a blowout second quarter. Revenue increased 34% year over year, and gross margin expanded 9.1 percentage points to 67.7%. Operating margin expanded 10.7 percentage points to 60.3%.

CEO C.C. Wei said, "Our conviction in the multi-year AI megatrend remains very high." Management raised its outlook for capital expenditures to between $60 billion and $64 billion, and CFO Wendell Huang explained that the company always plans well in advance, and doesn't foresee any bottlenecks in expanding capacity and meeting demand. That's great news.

The company also said that it's going to invest another $100 billion in its Arizona facilities, bringing the total to $265 billion.

However, the market seems to have big concerns about how this is all going to convert over the next few years.

How it impacts Nvidia

Wall Street has set a high bar for Nvidia's next earnings report, which is scheduled for the end of August. Nvidia typically clears Wall Street's bars with extra room, and it's likely to do that in the next report, too.

However, what has been emerging lately is that it's not enough. Nvidia stock has struggled to gain meaningful traction recently, and there's a good chance the market will not reward a robust report under almost any circumstances.

The good news is that both Nvidia and TSMC are more similar to Amazon and Shopify than Zoom in Fiverr in how they perform in market cycles. They have proven themselves over decades, adapting to new technology and trends.

The likelihood is that they'll manage through this cycle, whenever it ends. However, be prepared for dips along the way.

Jennifer Saibil has positions in Taiwan Semiconductor Manufacturing. The Motley Fool has positions in and recommends Amazon, Fiverr International, Nvidia, Shopify, Taiwan Semiconductor Manufacturing, and Zoom Communications. The Motley Fool has a disclosure policy.