Mr. Market Has the Taiwan Jitters, Trump Should Give Him a Chill Pill

Why is Mr. Market selling Taiwan Semiconductor (TSM), one of the most important and valuable companies on earth, for what appears to be at least a 50% discount?

And that’s not just since the recent tech pullback. TSM is always underpriced. It reigns supreme in the manufacturing end of the semiconductor business. It is currently the only company on earth that can manufacture the most demanding AI chips, for which it has more demand than it can fill. There is no hint of its technology leadership slipping away. It is the universal winner in the AI boom.

If Nvidia prospers, so does TSM. If competitors such as ADM (NYSE: ADM), Amazon (NASDAQ: AMZN), Google (NASDAQ: GOOGL), META (NASDAQ: META), or Microsoft (NASDAQ: MSFT) gain ground against NVDA, TSM wins. Every single one of those firms outsources their manufacturing to TSM, as do more than 500 other customers, including Qualcomm (NASDAQ: QCOM), which has largely moved away from Samsung (XKRX: 005930), and Apple (NASDAQ: AAPL), which long since abandoned Intel.

If, as we expect, wafer-scale computing from Cerebras and Tesla (NASDAQ: TSLA) eventually eclipses chips, guess who already manufactures their wafer-scale compute machines? (No prize for getting this one right).

How much is TSM worth? It’s selling at a PE (price earnings ratio) of 18.5, which works out to a market cap of $755 billion, far less than its top customers. We figure it’s worth at least half again as much.

We don’t do a lot of value investing at the Gilder Technology Report. We invest by “technology paradigms” in companies that have made correct crucial decisions on their technology path, often arising from the physics itself, and we generally hold those companies for long periods of time.

Nevertheless, just as a matter of interest, we applied the value guidelines developed by our favorite living value guru, Vitaly Katsenelson. Vitaly uses several valuation methods, our favorite being his “Real PE”. We like it because it is simple.

Vitaly starts with the basic price earnings ratio for a company that is profitable and financially sound but not growing. Ben Graham, the father of value investing, believed such a company was worth about eight times earnings, so Vitaly starts with a basic PE of 8.

Then he projects annual earnings growth based on the recent past. We used TSM’s five-year compound earning growth rate of 25%.

Then for every 1% of projected annual earnings growth up through 16%, multiply by 0.65. Add the result to that basic PE of 8. That brings TSM’s PE up to 18.4.

Then for every remaining point of projected growth, multiply by 0.5 and add the result to the PE. That brings our PE up to 22.9.

Add the dividend yield, currently 1.5, getting 24.4.

Finally, he offers formulas to adjust modestly up or down for business risk and financial risk. And get your answer.

We got 29, a more than 50% premium to the current PE of 18.5.

Why so cheap when everyone knows how important this company is and how powerful its technology lead?

Two reasons, we think.

The lesser reason is Trump talking about slapping tariffs on chips manufactured in Taiwan, presumably as a way to persuade TSM to bring its very best technologies to Arizona. But since the seven largest American companies by market cap all outsource their semiconductor manufacturing to TSM in Taiwan and owe to it much of their success, we assume Elon will whisper in President Trump’s ear and make that one go away.

The bigger reason is that Taiwan is claimed by China (a claim the United States conceded in 1972), is only 100 miles off the Chinese coast, and China has repeatedly threatened to retake it by force. A war over Taiwan would drive TSM stock down all too close to zero.

Can we ameliorate that risk, which endangers not only TSM but dozens of U.S. companies?

Only possibly, but here are some ideas we think could help.

1. Be honest with ourselves. If we fight a war in Chinese waters we will lose, badly. Virtual war games run by the U.S. Department of Defense all come to that conclusion. At risk is our entire carrier fleet, denied by Chinese satellites their traditional defense of hide and seek. Even if some of our carriers survived—because they are shielded by our extraordinary Aegis missile defense system—none of the transports would. Every soldier we sent to the Pacific on a transport would drown.
2. Be honest with the Taiwanese. “Strategic ambiguity,” if ever useful, is no longer. Taiwan should know what is increasingly obvious to all, we cannot go to war on China’s doorstep any more than China could win a war over Puerto Rico or Texas.
3. Even so, the disincentives against China taking the island by force are non-trivial. Their anxious neighbors—India, Japan, South Korea, Vietnam, Australia, the Philippines, and, yes, Russia, would be, if possible, even more alarmed and determined to arm against Chinese ambitions. China’s aspirations to be seen as a world peacemaker more benevolent than the United States would be bruised at best.
4. To enhance incentives to good behavior, the United States should replace our limp stick with a juicy carrot.
5. As we have proposed before, start by making Taiwan a tariff-free transit port for goods shipped from China to the United States.
6. Drop the meaningless war-monger posturing, which is so relentless it suggests there is nothing China could do to improve relations. Help them see a path to cordial relations with the United States and the value of such.
7. Having done that, we should mostly let the Chinese draw their own conclusions. But if we could get them privately to agree to a hands-off policy for another couple decades, it would be worth doing. A lot can change in 20 years. A lot has changed, though GOP hawks refuse to admit it.

An intact, world-beating TSM would be a jewel in China’s crown and a continued source of world economic domination for the United States.