Taiwan Semiconductor Stock: Buy Now or Wait for Earnings?

Key Points

• Taiwan Semiconductor Manufacturing stock is about to report quarterly earnings this week, and investors wonder what to do.
• After ASML's 16% sell-off, some may be spooked about what awaits the rest of the industry. This is why these indicators have become more important than ever. 
• Wall Street analysts and broader markets expect a premium performance from the stock, which is why they pay premium prices as well.

Earnings season is bringing investors the most awaited stock market results, this time not only the banking sector’s status and trends but also the semiconductor and chipmaking niche of the technology sector. Last quarter, investors gathered around the country to watch earnings results from some of the biggest names in the space to decide whether to buy or sell.

That includes stocks like Taiwan Semiconductor Manufacturing Co. NYSE: TSM, the global leader of chipmaking, with some of the biggest companies out there depending on its success. Then there is investor—and trader—favorite NVIDIA Co. NASDAQ: NVDA, which is also affected by how Taiwan and other major players perform during their quarters as a gauge of future expectations.

After a recent 16% sell-off from Taiwan Semiconductor’s main competitor outside of Asia, ASML Holdings NASDAQ: ASML, investors may have new reasons to worry about the future states of affairs in the chipmaking industry, wondering whether they are about to go into a low cycle after more than five years of above-average margins and profitability. If these fears turn out to be true, then Taiwan Semiconductor investors have a choice to make today.

What Markets Expect From Taiwan Semiconductor's Upcoming Earnings

Investors need to look at one key piece of information before Taiwan Semiconductor stock's earnings. The company's investor relations website has a report on monthly revenue, which has reported double-digit growth (on an annual basis) for every month so far into 2024.

However, this is not the end-all-be-all indicator, as many other financial metrics can show the market where the industry might be headed, such as gross margins. For Taiwan Semiconductor, gross margins came in at 53.2% for the quarter, though these margins were a bit higher at 54.1% for the same quarter last year.

A contraction in gross margins, signaling rising production costs or falling pricing power, could mean that the industry is headed into a lower demand (or higher inventory) environment today. If this is true, then ASML's contraction in bookings is only the beginning for the rest of the players in this space.

Despite seeing double-digit revenue growth over the year, Taiwan Semiconductor posted a net decline of 13.4% in operating cash flows, which often act as a proxy for a company's earning power over the measured period. These faltering metrics add pressure to the potential of Taiwan Semiconductor to report a strong quarter this week.

But all hope is not lost for the company, which is still beating expectations. That's why investors need to dig deeper into market expectations and decode a few metrics that are most often overlooked.

Markets are willing to overpay slightly for Taiwan Semiconductor stock compared to peers in the space today, especially regarding a price-to-book (P/B) and price-to-earnings (P/E) ratio. Trading at a 33.5x P/E places Taiwan Semiconductor at a premium to the semiconductor industry's average valuation of 29.5x today.

The same trend extends to Taiwan Semiconductor's P/B valuation of 8.6x today, also above the industry's 7.0x valuation today. Markets typically pay a premium for companies they expect to outperform in the near future, which is especially the case today considering earnings are this week.

Does Wall Street Agree With the Market's Premium Valuation?

Some analysts got ahead of the earnings curb for Taiwan Semiconductor stock’s earnings, particularly those at Susquehanna. As of August 2024, these were the latest set of analysts to express their views on the chipmaker’s price, reiterating a “Positive” rating alongside a $250 a share price target.

These are the outliers, above the consensus price target of $200 a share today. To prove these Susquehanna analysts right, Taiwan Semiconductor stock would have to rally by as much as 32% from where it trades today, not to mention a new all-time high valuation for the company.

Another gauge for investors to consider, which adds to the bullish evidence to support holding this stock through earnings, is the fact that the stock’s short interest has declined by 0.3% over the past month alone. This is part of a larger quarterly decline from $5.6 billion to $4.5 billion in short interest today.

Slowing finances don’t have the strength bears thought they had, a trend investors can confirm by looking at the premiums being paid for Taiwan Semiconductor stock today and the bearish capitulation over the quarter. Bullish factors outweigh the bearish ones, making this a stock to hold through the upcoming earnings announcement.