No company has been a bigger winner than Nvidia (NASDAQ: NVDA) as nearly every tech company has collectively poured billions of dollars into developing their generative AI (artificial intelligence) capabilities. The company has added $2.5 trillion to its market cap over the last two years as sales and profits exploded with the demand for its GPUs.
The chipmaker has shown incredible pricing power amid the strong demand. That's evidenced by its gross margin expanding into the upper 70% range. And with the booming sales growth, it's seen very high operating leverage, which translates into massive bottom-line growth. To be sure, Nvidia's performance as a business, not just a stock, over the last two years has been nothing short of phenomenal.
But Nvidia isn't the only AI chip stock in the market. And CEO Jensen Huang just explained why another company may be worth owning, perhaps even more so than his own company.
"The world's best by an incredible margin"
At an investor conference earlier this month, Huang had high praise for one of Nvidia's biggest business partners: Taiwan Semiconductor Manufacturing (NYSE: TSM), known as TSMC.
TSMC is the largest semiconductor foundry, or fab, in the world. When a company like Nvidia designs a new chip, it takes it to TSMC to actually print the design on a silicon wafer. That takes incredible precision and innovative technical capabilities. TSMC is the top choice for many chip designers, including Nvidia. TSMC commands over 60% of global spending at chip foundries.
"We're fabbing out of TSMC because it's the world's best," Huang said. "And it's the world's best not by a small margin, it's the world's best by an incredible margin."
That's why Nvidia and almost anyone else that needs to produce cutting-edge chips picks TSMC over its competitors. Huang did say Nvidia could switch to another foundry if it had to. But he also said competitors' capabilities can't match TSMC's and it would result in less performance or higher cost.
He also praised TSMC's ability to scale its operations. When Nvidia saw demand for its chips skyrocket, TSMC was able to help it meet that growing demand so it could take advantage of the opportunity. Any business that needs to be able to scale up needs to work with TSMC.
Importantly, TSMC's position as the market leader, winning the majority of revenue in the industry, ensures it'll stay in its leading position. It has more money to reinvest in R&D and create the next generation of processes. The virtuous cycle leads to more and more big contracts with big tech companies designing super high-end chips over time.
TSMC still has a lot of growth left
TSMC might be the biggest company in the industry, but there's still a ton of growth for it to capture.
Tech companies are all planning to ramp up their spending on AI systems in data centers. Total spending on AI chip content and related systems is forecast to reach $193.3 billion in 2027, according to estimates from IDC. That's up from $117.5 billion this year, translating into an 18% compound annual growth rate over the next three years.
Importantly, TSMC is highly agnostic to that growth. Whether that growth comes from Nvidia, one of its competitors, or custom chips designed by its biggest customers, TSMC is likely winning the bulk of those contracts. In fact, the virtuous cycle and TSMC's leadership in cutting-edge chips means it could grow that part of its business even faster than the industry. On top of that, TSMC has room to improve its margins.
That's all reflected in analysts' forecasts for the company over the next five years. The average analyst expects TSMC to grow earnings over 20% per year for the next half-decade. But you don't have to pay up for that growth. Shares currently trade at just over 20 times the consensus 2025 earnings forecast.
Few other companies offer that same level of potential growth at that price. So, not only is it the world's best fab by an incredible margin, investors can buy a stake in it right now at an incredible price.
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Adam Levy has positions in Taiwan Semiconductor Manufacturing. The Motley Fool has positions in and recommends Nvidia and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
Nvidia's CEO Just Explained Why This Is the Artificial Intelligence (AI) Chip Stock to Own was originally published by The Motley Fool