This AI Chip Stock Looks Like a No-Brainer Buy Right Now

Key Points

• TSMC holds a 70% market share in the semiconductor foundry industry.

• It plays a critical role in the AI pipeline as the go-to chip manufacturer.

• The stock trades at a premium, but it's well worth it given TSMC's dominance.

• 10 stocks we like better than Taiwan Semiconductor Manufacturing ›

Raise your hand if you've heard the following two words over the past couple of years: artificial intelligence (AI). Chances are that virtually everyone reading this would have their hands raised. AI has been the hottest topic in the stock market and business world over the past couple of years, and there's probably not even a close second.

Since the technology hit the mainstream due to the success of generative AI tools like ChatGPT, it has become virtually impossible to escape. With this increased interest in the technology has come increased investor interest in companies dealing with AI in almost any capacity. And this has led to many of these companies' valuations surging to unprecedented levels.

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Although AI consumer applications are what most people know and interact with, at the heart of the technology are AI chips. If you're looking to take advantage of a dominant company in the industry, look no further than Taiwan Semiconductor Manufacturing (NYSE: TSM) -- also known as TSMC. It's by far the biggest no-brainer AI chip stock to buy right now.

Image source: Getty Images.

TSMC is the go-to chip manufacturer

TSMC is the world's leading semiconductor (chip) foundry. The foundry business model means that it doesn't produce chips that can be bought in stores or online; instead, companies come to TSMC with their chip designs and TSMC uses its manufacturing power to bring the chips to life.

No chip manufacturer comes close to Taiwan Semiconductor's abilities, making it the go-to for most of the world's top tech companies. Apple uses TSMC for its hardware; Qualcomm uses it for processors; Tesla uses it for self-driving chips; Advanced Micro Devices uses it for its central processing units (CPUs); and Nvidia notably uses it for its graphics processing units (GPUs).

These are just a handful of TSMC's clients, too. Dozens of others rely heavily on the company. As of the second quarter, TSMC had a 70% market share in the global foundry market, according to research company TrendForce. This explains why the company's revenue and profits have soared over the past few years.

TSM Revenue (Quarterly) data by YCharts

The AI pipeline starts with TSMC

To understand the importance of TSMC to the AI world, it's helpful to work backward, starting with the end-user AI applications that many people interact with today. These applications must be trained using vast amounts of data (and I do mean vast). The size of this data means that AI developers must rely on data centers, which allow for the storage, processing, and scaling of these massive AI models.

Inside these data centers are specialized chips like Nvidia's GPUs, AI accelerators, and other processors. You can think of these as the engines of data centers. However, none of this would be possible without TSMC manufacturing the chips that these engines rely on.

TSMC is currently the only company that produces these chips at the efficiency and scale that companies need. It's as important to the AI pipeline as any company.

A premium price, but well worth it

At the time of this writing, TSMC shares are trading at around 23.6 times forward earnings estimates, which puts it in the premium category by many standards.

TSM PE Ratio (Forward) data by YCharts

Given TSMC's positioning as the undisputed chip king, this valuation seems well worth it and justified. Few companies have a stronger hold on their respective industry than TSMC, so it makes sense that the stock would be trading at a premium.

In some cases, it would be cause for a pause, but in this case it's not something that should discourage investors from investing in the company. TSMC has the market share, earnings growth, and growth outlook to justify it. It's a stock I plan to hold in my portfolio for quite some time.

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Stefon Walters has positions in Apple and Taiwan Semiconductor Manufacturing. The Motley Fool has positions in and recommends Advanced Micro Devices, Apple, Nvidia, Qualcomm, Taiwan Semiconductor Manufacturing, and Tesla. The Motley Fool has a disclosure policy.