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Over the past year, Taiwan Semiconductors (NYSE:TSM) has delivered a strong 25% return to shareholders. This return has increased shareholder value by over $20 billion and has propelled the company to new 9 year highs. Through this article, I will investigate the fundamental drivers of this organization and argue the case that TSM may have several more quarters of gains in the future.

A Volatile History of Returns

In order to examine TSM from a fundamental standpoint, I have relied heavily on return on assets and return on equity. Return on assets is the net income of the firm divided by average total assets. This ratio is important in that it allows an analyst to understand how efficiently the organization uses its asset base to generate profits. Return on equity is the net income of the firm divided by directly-invested shareholder equity. Return on equity tells the research how effectively management utilizes investments to bring income to the firm. The chart below shows 10 years of return on assets and return on equity for TSM.

click to enlarge images

The first thing that investors should notice is that TSM has a very volatile history of returns. Ever since 2004, returns have oscillated upwards and downwards in tandem. While these returns have been volatile, they have also been predictable. For example, if an investor were to purchase the security during the first quarter in which returns increased and then sell during the first quarter in which returns decreased, he or she would have perfectly called the fundamental tops and bottoms of TSM over the past decade. This is very important in that it shows us that TSM's business operating cycle, while volatile, tends to trend fairly consistently. Between the years of 2004 and 2009, return on assets and return on equity essentially oscillated around 22%. This period was marked with similar oscillation in the stock price in that the security was bound between $7 and $11 for these 5 years. In 2009, the global recession finally affected TSM and performance collapsed to 5 year lows. This collapse in performance was associated with a likewise decrease in stock price in which shares declined around 35%. In the second half of 2009, returns once again increased and between 2010 and 2011, the share price rose nearly 30%. The decline in returns at the tail end of 2011 signaled a 15% drop in share price until the year 2012, when the organization once again resumed a fundamental uptrend.

The study of past organizational returns and stock price change leads to a very interesting relationship. As TSM improves fundamentally, its stock price tends to increase as well. This makes intuitive sense in that the market is more than likely to allocate capital to a firm that is delivering stronger returns than to a firm which is not. Through the clear cyclicality of this relationship, we are provided with an excellent investment opportunity. Beginning in the second half of 2012, return on assets and return on equity for TSM began an uptick. This uptick in performance was met with a 23% surge in share price. While this leap in share price propelled the stock price to 9 year highs, the fundamental performance of TSM is still at relative lows. For this reason, I believe that an investment catalyst is present. It has been seen that for the past 10 years returns have driven share price. Additionally, as demonstrated, TSM's returns tend to be very predictable in that a change in direction has signaled the bottom and top of each of TSM's troughs and peaks for the past decade. If history is to be a rough guide to the future, then this signals a high probability of increase in returns in the following quarters. For this reason, I believe that investors should consider purchasing TSM's stock.

Technically Speaking

I strongly believe that TSM will continue its fundamental growth in the following quarters. Even though I believe that share price will increase in tandem to firm performance, I do not advocate immediately purchasing the stock. I believe that investors should wait to purchase the security until price has established a new high, signaling a resumption of the current uptrend. Technically speaking, no new shares should be purchased until price is able to overcome $16.60 per share. If a week is able to end above this threshold, then I believe that a long trade should be initiated. It is entirely possible that this analysis could be ill-timed and the market could reverse its gains. For this reason, I also advocate that investors use a stop-loss order to mitigate risks. Specifically, I believe that all shares should be sold if price falls below $14.75. As seen in the chart below, this level has possessed significance in that the bulls and bears have found resistance and support here 4 times in the past 10 months. I believe that if price closes below this point, all shares should be exited and this analysis should be considered ill-timed.

Source: Cyclical Buying Opportunity In Taiwan Semiconductors