Nvidia (NVDA -2.20%) maintains its commanding position in the market, providing the majority of semiconductors utilized in data centers for artificial intelligence (AI) applications. The company has recently unveiled an impressive quarterly earnings report, pushing its stock price closer to unprecedented all-time highs. Investors remain optimistic about Nvidia’s future, but it’s crucial to approach investments with caution and not to concentrate all resources in one area (the pun is intended). While Nvidia leads in many aspects, it is not the sole beneficiary of the surging demand for AI chips. Major players like Alphabet‘s Google and Amazon are developing their own bespoke chips tailored for distinct AI workloads within their cloud infrastructures, which has resulted in significant growth opportunities for other prominent semiconductor manufacturers.
Notably, shares of Broadcom (AVGO -2.88%) and Taiwan Semiconductor Manufacturing (TSM -2.04%) have seen remarkable increases of 73% and 29%, respectively, significantly outpacing Nvidia’s 18% return over the past year. Investing in these chip manufacturers can provide greater exposure to the escalating demand for AI semiconductor solutions in the rapidly evolving data center market.
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1. Explore the Investment Potential of Broadcom
Broadcom stands out as a premier provider of custom AI accelerators (also known as XPUs) and networking solutions tailored for data centers and various other sectors. The company’s networking division supplies essential components that facilitate high-speed data transfer, a critical requirement as hyperscalers transition to more sophisticated and demanding AI workloads. Broadcom has consistently demonstrated its prowess, reporting five consecutive quarters of impressive revenue growth of 20% or more. In the latest quarter, revenue attributed to AI initiatives surged by an extraordinary 46% year over year, underscoring the company’s robust performance in this burgeoning market. Furthermore, Broadcom has successfully converted this growth into substantial profits, achieving free cash flow of $6.4 billion last quarter, which translates to an impressive 43% profit margin on its revenue.
The revenue generated specifically from AI networking, including Broadcom’s Ethernet networking products, skyrocketed by 170% year over year, now constituting nearly half of the company’s total revenue from AI. This phenomenal growth in networking indicates a significant escalation in computing power necessary for the development of the next generation of AI applications and services. Moreover, Broadcom is also delivering XPUs that are more cost-effective for specific tasks compared to Nvidia’s general-purpose chips. The company has indicated that at least three of its clients are set to deploy 1 million custom AI-accelerated clusters by 2027. During its recent earnings call, Broadcom reported that these large hyperscalers remain “unwavering” in their commitment to ongoing investments in the near future. The long-term outlook for demand for custom chips is promising, indicating robust support for shareholder returns over the upcoming years. Management anticipates that demand for custom XPUs will continue to accelerate through 2026, positioning Broadcom as an attractive investment opportunity despite a relatively high forward price-to-earnings ratio of 38.
Image source: Taiwan Semiconductor Manufacturing.
2. Taiwan Semiconductor Manufacturing: A Cornerstone of Chip Production
Taiwan Semiconductor Manufacturing, commonly referred to as TSMC, plays an indispensable role in the global supply chain of the semiconductor industry. It holds the title of the largest chip foundry, commanding over 65% of the total market share, as reported by Counterpoint. TSMC manufactures chips for a diverse range of companies, including industry leaders such as Nvidia, Broadcom, Advanced Micro Devices, and Apple, alongside various hyperscalers. Recently, the stock has surged to new heights following a remarkable quarterly performance, where revenue in U.S. dollars increased by 35% year over year. This impressive growth occurred despite a downturn in smartphone sales during the quarter, which represents more than a quarter of TSMC’s total revenue, primarily attributed to seasonal demand fluctuations.
For decades, TSMC has made substantial investments in pioneering chip-making technology to satisfy customer demands for the world’s most advanced chips. Its competitive edge stems from its exceptional manufacturing capabilities and vast chip production capacity, enabling the company to produce over 16 million 12-inch equivalent wafers annually. These advantages have allowed TSMC to achieve an outstanding profit margin of 41% based on trailing-12-month figures. Looking ahead, TSMC intends to double its chip-on-wafer-on-substrate (CoWoS) capacity by 2025, reflecting its commitment to supporting the escalating demand that Nvidia and other clients are currently experiencing. Additionally, TSMC has announced a significant investment of $165 billion dedicated to establishing new manufacturing facilities in the U.S., along with expansion plans in other global markets.
In a noteworthy development, revenue from AI accelerators experienced a threefold increase in 2024, with management projecting a doubling of this revenue in 2025. Furthermore, TSMC anticipates that demand for AI chips will grow at an annualized rate exceeding 40% through 2029. Given the current market landscape, shares of Taiwan Semiconductor present a compelling value proposition among semiconductor stocks. The stock trades at a reasonable 23 times the projected earnings for 2025, despite analysts forecasting an impressive 21% annualized earnings growth. While earnings multiples exceeding 20 are historically considered high for chip stocks, the current environment is characterized by a once-in-a-generation growth surge that is likely to yield exceptional returns for investors well into the latter part of the decade.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Ballard has positions in Advanced Micro Devices and Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon, Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
