AMD Vs. Taiwan Semiconductor Stock: Which Is The Better Buy?
- The semiconductor industry has experienced a significant sell-off in recent weeks, due to rate hike worries and escalating global tensions.
- AMD and TSM both have a compelling business outlook going forward. AMD is currently growing faster on a relative basis.
- Neither company is especially expensive, but TSM looks like an outright bargain.
- Both companies are exposed to geopolitical risks, primarily the brewing Taiwan-China confrontation.
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Semiconductor stocks have come under pressure in recent weeks on the back of rate hike fears and due to worries about the impact of recently-announced sanctions due to the Russia-Ukraine war.
Advanced Micro Devices, Inc. (NASDAQ:AMD) and Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) are two of the largest semiconductor companies in the world. In this report, we'll try to evaluate which is the more favorable pick today.
What Are The Differences Between AMD And TSM Stock?
Investors have to decide whether they want to invest in a semiconductor manufacturer that produces the actual product for other companies, which would be TSM, or whether they want to go with AMD, a semiconductor designer without in-house production. Due to not owning any fabs itself, AMD operates a very capital-light business that generates strong free cash flows. TSM, on the other hand, needs to invest heavily in new fabs constantly, which requires heavy capital spending. TSM's business model also has advantages, however. TSM benefits from overall demand growth, no matter whether chips are sold by AMD, NVIDIA (NVDA), or many other fabless operators. One could thus say that TSM is the more diversified semiconductor player, as its success is not tied to demand growth for a single company. Instead, TSM benefits from broad demand growth for the industry as a whole.
AMD Stock Key Metrics
Advanced Micro Devices, Inc. delivered very strong Q4 earnings results in February. During the quarter, AMD was able to grow its revenue by 49% year over year, while earnings per share rose to $0.92 -- up around 80% versus the previous year's quarter.
The company's strong underlying growth allowed AMD to grow its free cash flow to more than $3 billion in 2021, which was almost twice as much as during 2020. Relative to a current market capitalization of more than $180 billion, $3.2 billion in free cash flow doesn't seem like a lot, as this equates to a ~60x free cash flow multiple. But we should consider that AMD will most likely experience solid organic business growth in 2022, and on top of that, the company has closed its acquisition of Xilinx in February. This has made AMD's share count rise by a lot, which is factored into the current market capitalization. Earnings and cash flow contributions from this takeover are not factored into AMD's trailing results yet, however. This distorts the valuation on a trailing basis to some degree, which is why AMD is cheaper than it looks -- although it is still not cheap in absolute terms.
TSM Stock Key Metrics
Taiwan Semiconductor reported its most recent quarterly results in January. During the fourth quarter, TSM grew its revenue by 24% year over year, and its earnings per share were up around 20% over the same time frame. That's not as strong as what AMD delivered, and TSM also did not outperform analyst expectations to a similar level as AMD did. Still, TSM's results, with growth in the 20% range were compelling, and investors should consider that TSM's revenue and earnings base is way larger than that of AMD, which means that growing by 40%, 50%, or more is almost impossible. The law of large numbers dictates that maintaining extraordinary growth rates becomes harder and harder the larger a company becomes, which is why TSM's lower relative growth isn't surprising.
TSM's outlook for the current quarter, Q1, is very encouraging. The company forecasts sequential growth of around 10% when it comes to its revenues, while also forecasting gross margin and operating margin expansion of around 150 base points, respectively. The combination of higher revenues and stronger margins should allow TSM to generate highly compelling earnings growth this quarter. Importantly, TSM's outlook for Q1 is strong despite the fact that the current quarter included the Chinese New Year holidays, where business activity generally slows down for some time.
Are AMD And TSM Good Long-Term Investments?
In order to decide where to invest, it makes sense to look at a couple of important themes. The first one is a company's growth or business outlook, while valuation and risk factors are to be considered as well.
Looking at AMD's growth potential over the coming years, the skies are looking blue. The company's line-up includes strong products such as its 5nm EPYC Genoa chips that will be released this year. Intel (INTC), one of AMD's key competitors in the data center space, will still be selling 10nm chips such as the Sapphire Rapids Xeon at the time AMD is selling its high-end 5nm chips. This tech lead could easily result in AMD taking further market share from Intel in the next couple of quarters, although it is of course not guaranteed that AMD will have a tech lead forever. On top of the strong competitive position, AMD also benefits from the fact that the overall market continues to grow rapidly. AMD's CEO Lisa Su has lauded the very "strong demand" in the server market this year, and due to macro trends such as digitalization, big data, autonomous driving, and many more, global server and data center demand will most likely continue to grow for many years to come.
Another important growth driver is the fact that AMD has executed very well from a supply chain perspective. While many other companies are having issues due to parts shortages, transportation bottlenecks, raw material costs rising, etc. AMD has been able to execute very cleanly. AMD's CTO Mark Papermaster has stated that the company's "supply chain team has worked to make sure that we have months and years of forecast ahead into our supply chain". Lisa Su has also reiterated that the company was not facing severe supply chain issues and that she feels "very good" [see link above] about meeting guidance numbers this year.
From a valuation perspective, AMD isn't looking as strong, however. Last fall, in an article on AMD, we argued that the valuation was rather stretched. Since then, shares have dropped by 27%. Combined with underlying business growth since then, shares have become more reasonably valued, but they are still not cheap. At current prices, AMD is valued at 28x this year's profits. This doesn't seem especially unreasonable when we consider AMD's strong growth outlook, but a high 20s earnings multiple isn't a bargain valuation, in my opinion.
Looking at TSM, the growth outlook is quite sound as well. TSM, due to being in business with many different companies around the world, benefits from broad-based chip demand growth in 2022 and beyond. It is not tied to the success of individual product lines in the way AMD, NVIDIA, and others are. Due to the ongoing global chip shortage, TSM is in a strong negotiating position versus the companies it does business with. Demanding higher pricing shouldn't be an issue for TSM, as its counterparties are highly inclined to find manufacturing capacity. This likely explains why Taiwan Semiconductor Manufacturing Company is forecasting margin expansion this year -- pushing through price increases in a tight market should allow them to more than offset higher input costs.
From a valuation perspective, TSM looks quite attractive. Shares have declined to just above $100, down around 25% from recent highs. This has made TSM's earnings multiple, based on forecasts for 2022, drop to just 19.5 at the time of writing. A company with an excellent market position, benefiting from strong macro tailwinds, which has delivered growth of more than 20% in the most recent quarter, seems quite attractive at a high-teens earnings multiple, I believe. Notably, the recent price decline has also made TSM's dividend yield rise to 1.7%, which is meaningfully above the S&P 500's dividend yield of 1.4%.
Is AMD Or TSM Stock A Better Buy?
Looking at the risks for both companies, geopolitics is the most noteworthy one for both companies. Taiwan Semiconductor Manufacturing is located in Taiwan, and would thus be highly exposed if the China-Taiwan situation escalated. That may not be overly likely in the near term, but the Russia-Ukraine crisis shows that geopolitical tensions can escalate even in today's world. In a potential escalation, huge disruptions to TSM's operations would be likely, and investors might experience a permanent loss of capital. This is the key risk for TSM, I believe. Apart from that, risks do not seem high, as macro tailwinds, a strong market position, and diversification across many customers result in relatively low operational risks.
AMD is not a Taiwan-based company, but it would still be very exposed to a potentially escalating conflict between Taiwan and China. TSM is a core manufacturing partner for AMD, thus AMD would likely experience huge disruptions in case that conflict ever escalated. It would likely be less impacted than TSM, however, as it could search for other manufacturing partners located outside of Taiwan. AMD's near-term outlook is very strong, but there are still some other risks to its operations. We have seen that AMD pulled ahead of Intel tech-wise in the recent past, which indicates that the reverse might happen in the future, too. Intel spends a lot more on R&D compared to AMD, thus there is a potential risk of Intel surpassing AMD tech-wise at some point in the future. Due to AMD's strong current execution and Intel's process issues, that will most likely not happen in the near term. But there is no guarantee that AMD will still have a market position this strong in 2030, compared to Intel, NVIDIA, etc. Investors thus should keep an eye on AMD's operational progress compared to what its peers are coming up with.
Overall, I think neither company is looking bad right here. AMD is experiencing very strong growth and has an attractive product lineup, while its valuation is reasonable, with an earnings multiple in the high 20s. I personally deem TSM even more attractive, however. TSM is even more dominant in its market, is more diversified, and trades at a very inexpensive valuation of less than 20x this year's expected net profit.
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Analyst’s Disclosure: I/we have a beneficial long position in the shares of TSM, INTC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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