Warren Buffett recently announced his intention to retire after a remarkable life and career that saw him captain his conglomerate for 55 years and build vast sums of wealth for himself and his shareholders.
There are so many lessons to learn from Buffett, many of which I’ve shared in the past.
But what I think is particularly striking in light of his pending retirement is just how long term Buffett’s thinking has been.
Buffett thinks and acts with decades in mind.
While none of us mere mortals will ever build anything close to what Buffett did, we can certainly apply the same kind of long-term mindset and achieve incredible results.
And one of the best investment strategies with which to apply a long-term approach is dividend growth investing, which is a strategy that involves buying and holding shares in high-quality businesses paying shareholders steadily rising cash dividends.
You can find stocks that qualify for this strategy by opening up the Dividend Champions, Contenders, and Challengers list.
This list has pulled together data on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
I’m still in the early innings myself, but I’ve been consistently investing via this strategy for 15 years now.
That consistency has greatly helped me as I’ve gone about building the FIRE Fund – my real-money portfolio that generates enough five-figure passive dividend income for me to live off of.
I’ve been in the extremely fortunate position of being able to live off of this passive dividend income for a number of years, even having the ability to retire in my early 30s.
My Early Retirement Blueprint shares how something like that is possible for almost anyone (even if you don’t earn a high income).
Another Buffett-ism is a relentless focus on valuation at time of committing to any investment.
Like the great man told us, price is what you pay, but value is what you get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.
It’s protection against the possible downside.
Being a long-term dividend growth investor and smartly focusing on valuation when making investment decisions can lead to tremendous amounts of wealth, passive dividend income, and independence over time.
Of course, being smart on valuation first requires one to have a complete grasp of the concept.
Well, just in case you don’t yet feel fully confident on all of this, make sure to read Lesson 11: Valuation.
Penned by fellow contributor Dave Van Knapp as part of an overarching series of “lessons” designed to teach dividend growth investing, it describes valuation using simple terminology and even includes a template you can use to quickly and roughly value just about any dividend growth stock you’ll run across.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Taiwan Semiconductor Manufacturing Company Limited (TSM)
Taiwan Semiconductor Manufacturing Company Limited (TSM) is a Taiwanese multinational semiconductor contract manufacturing company.
Founded in 1987, Taiwan Semiconductor Manufacturing Company Limited (hereon referred to as TSM) is now a $789 billion (by market cap) manufacturing might.
With over 60% market share, TSM is the world’s largest dedicated chip foundry.
And just to quickly point out TSM’s longstanding leadership, Morningstar states the following: “TSMC has been leading node advancement and maintaining over 50% market share since the early 2000s, and its gross and operating margins have been about twice as high as those of its closest peers for years.”
Major customers for TSM include: Apple, Broadcom, Nvidia, and Qualcomm.
TSM’s advanced manufacturing processes are unrivaled in scale, scope, and technological expertise.
That’s true today, and it was true 20 years ago.
This isn’t just one of the largest companies in the world, but it’s also one of the most important; without TSM’s leading-edge wafer fabrication processes, many of the world’s end products which require high-end semiconductors would cease to be manufactured and available for usage.
And since humanity relies on many of these end products for everyday life, keeping the chips coming is of the utmost importance.
There are many very important technology companies in existence, but TSM might just be the most important of all.
Moreover, as more and more companies in the technology ecosystem have increasingly moved to a fabless model, TSM has taken on more manufacturing duties and become that much more critical to the global supply chain.
In addition, the large cloud providers (i.e., hyperscalers) of the world now demand chips of their own, which leads right to, basically, the only game in town: TSM.
That’s really the crux of the matter: Almost all roads (as they pertain to advanced semiconductor manufacturing) these days lead to TSM.
This company is practically the definition of a wide economic moat.
With its huge share of market, massive scale, and peerless manufacturing capabilities, TSM is nearly untouchable.
Even if the company were to start stumbling today, it would likely take years for any viable competitor to really start eating TSM’s lunch.
Anyway, to the contrary, every indication points to TSM being at the top of its game.
It dominates the industry, is advancing to the 2nm node, and building out new fabs globally in order to diversify its footprint outside of its native Taiwan.
All I see is mastery, expansion, and high rates of growth across the company’s revenue, profit, and dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, to that last point, TSM has generally increased its dividend on an annual basis (in its native currency) since it initiated its cash dividend in 2003 – that’s more than 20 years ago.
That said, there were back-to-back years of NT$8 per share in 2017 and 2018, taking the company’s dividend growth streak to seven consecutive years.
Still, there’s a clear commitment from TSM to paying shareholders higher dividends.
That commitment and intentionality is further expressed by TSM’s own statement on this matter: “TSMC intends to maintain a sustainable and steadily increasing cash dividend, and to distribute the cash dividend each year/quarter at a level not lower than the year/quarter before.”
Music to my ears.
Its five-year dividend growth rate is 15.8%.
A mid-teens dividend growth rate is impressive.
What’s especially impressive is this kind of growth rate coming out of such a large firm.
This isn’t some young upstart benefiting from small size and easy comps for relative growth; yet, in spite of its large size, TSM is growing its dividend quite quickly.
On the flip side, there’s a yield trade-off here.
The stock yields just 1.3%.
To be honest, this isn’t bad at all for the growth one gets.
A lot of high-quality compounders actually often offer even lower yields.
I’d also point out that this does beat the what the broader market offers, and this yield is close to its own five-year average.
I mean, one can’t expect a super high yield when there’s mid-teens growth present.
What precisely is the “right” amount of yield in that kind of case is up to the individual investor to decide, but I think 1.5% is quite reasonable.
With a payout ratio of 39.8%, TSM’s dividend is very sustainable and positioned to continue growing roughly in line with (or even slightly faster than) the firm itself.
These dividend metrics are right up there with some of the very best high-quality compounders from the US.
Revenue and Earnings Growth
As elevated as these numbers may be, though, many of them are based on the past.
However, investors must always be anticipating the future, as today’s capital is risked for tomorrow’s rewards.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will be highly useful for the valuation process.
I’ll first show you what the business has done over the last decade in terms of its top-line and bottom-line growth.
I’ll then reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast in this manner should give us the kind of information necessary to develop an ability to roughly judge where the business may be going from here.
TSM increased its revenue from NT$844 billion in FY 2015 to NT$2.9 trillion in FY 2024.
That’s a compound annual growth rate of 14.7%.
This is exceptional.
I’m usually looking for a mid-single-digit (or better) top-line growth rate out of a large, mature firm (and TSM is definitely large and mature), but TSM blows this kind of expectation out of the water.
Meanwhile, earnings per share increased from NT$11.82 to NT$45.25 over this period, which is a CAGR of 16.1%.
Fantastic.
We can obviously see that the mid-teens dividend growth has been fueled by mid-teens business growth, and I see much more of both ahead for TSM and its shareholders.
There was some excess bottom-line growth over the last decade, which was fueled by margin expansion (from extremely healthy levels into now the stratosphere).
Looking forward, CFRA is forecasting a 15% CAGR for TSM’s EPS growth over the next three years.
I see absolutely nothing wrong with this forecast out of CFRA.
If anything, it may prove to be too cautious.
CFRA states that its bullish outlook “…reflects TSM’s dominant share in leading-edge nodes, expanding margins, and AI/SoC/crypto leadership.”
CFRA then follows that up with this: “Strong cash flow and net cash (17% of assets) support future investments. We expect mid-teens earnings growth in 2025- 2026 from N3 (Apple, Qualcomm SoCs) and N4/ N5 (AI, crypto), with edge-AI growth potential from 2026. The 20% five-year revenue CAGR target looks achievable with EBIT margins staying above 42%.”
The above says it all.
TSM is completely dominant when it comes to leading-edge nodes.
The 20% target that CFRA quickly notes relates to TSM’s own five-year revenue CAGR (which was put forth last year).
If we double-click on recent results, TSM printed 30%+ YOY revenue and EPS growth, respectively, for FY 2024.
So we can see an acceleration off of the mid-teens growth (which was already impressive) that was demonstrated over the last decade.
TSM has a history of making good on its ambitious goals, and 20%+ revenue growth would easily allow for like-or-better EPS (and dividend) growth.
And what all of this does is, it paints a picture of much more high dividend growth (at a mid-teens rate or better) over the foreseeable future.
About 1/3 of the company’s revenue is derived from smartphones, but it’s possible that future primary tech devices (such as robots or glasses) will require even more advanced semiconductors (and more of them).
Again, the starting yield isn’t juicy.
But TSM has been, is, and will likely remain a compounding machine.
For those who understand and appreciate the power of compounding over time, TSM is a shining star.
This stock’s 10-year CAGR (including reinvested dividends) is 25%, which resulted in a nearly 10x on an initial investment 10 years ago.
The only thing chink in the armor here is TSM’s location.
With neighboring China openly declaring its intention to eventually “acquire” Taiwan and “unify” the two, there is a major geopolitical overhang on TSM.
If that overhang weren’t present – say, if TSM were located in the US – I have no doubt that the stock would be valued far, far higher than it is.
And even with the geopolitical discount, shares aren’t exactly in bargain basement territory.
Still, if one can accept the situation with China, and if one is looking for a high-quality compounder of the highest order, this stock is about as appealing as it gets.
Financial Position
Moving over to the balance sheet, TSM has a stellar financial position.
The long-term debt/equity ratio is 0.2, while the interest coverage ratio is well over 100.
As great as these numbers (particularly the latter) are, they actually belie the true health of TSM’s balance sheet.
I say that because (as CFRA quickly highlighted earlier) TSM is sitting on net cash of more than $30 billion.
The company’s long-term credit ratings are well into investment-grade territory: Aa3, Moody’s; and AA-, S&P.
Large technology firms are renowned for their cash-rich balance sheets, and TSM is no exception.
Another thing large tech firms are known for is high degrees of profitability.
Again, TSM doesn’t disappoint.
Return on equity has averaged 31.2% over the last five years, while net margin has averaged 39.8%.
That margin is otherworldly, and it’s expanded from from closer to the 30% area a decade ago.
ROIC is also routinely over 20%, showing very high returns on capital.
TSM is a wonderful business from pretty much any angle.
And with economies of scale, market share leadership, established/entrenched relationships with the world’s best customers, technological know-how, R&D, IP, and brand reliability, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Litigation, regulation, and competition are omnipresent risks in every industry.
Although TSM’s industry is extremely competitive, TSM is in a class of its own and has largely stayed ahead of its competitors.
The biggest risk of all is probably TSM’s location: TSM’s Taiwan base makes it vulnerable to a possible Chinese takeover (although TSM’s footprint expansion outside of Taiwan does mitigate this risk somewhat).
The business model relies heavily on capital expenditures, which is currently exacerbated by TSM’s global expansion efforts.
Semiconductor manufacturing/demand has historically been cyclical, which is something to be aware of, but TSM’s growth has actually been smoothly secular in almost every way.
About 1/3 of the company’s revenue is derived from smartphones, and any changes in the smartphone market could impact TSM (but future devices may actually result in a demand boost for more advanced chips).
There is some customer concentration risk, as only a few major tech companies worldwide have the financial wherewithal to order from TSM at scale.
Being (increasingly) a global company, TSM is exposed to currency exchange rates and geopolitics (particularly as it relates to China).
TSM’s fabs require immense amounts of resources, which exposes the company to possible shortages here.
Overall, other than the Taiwan base/concentration, which is slowly being diluted by global expansion, I see a low risk profile relative to just how terrific the business is.
Also, with the valuation being where it’s at, I don’t think this terrific nature is being fully appreciated…
Valuation
The stock is trading hands for a P/E ratio of 23.5.
That is almost obscenely low for a company with this kind of growth and quality.
That puts the PEG ratio at barely over 1.
This is also sightly lower than the stock’s own five-year average P/E ratio of 22.5, which also is not demanding at all.
There are many companies out there nowhere near TSM’s quality, but their shares have far higher valuations.
Again, I think a lot of this comes down to a geopolitical discount.
If TSM were located almost anywhere else in the world, this P/E ratio would probably be closer to 30.
Also, the yield, as noted earlier, is close to its own five-year average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a two-stage dividend discount model analysis.
I factored in a 10% discount rate, a 10-year dividend growth rate of 16%, and a long-term dividend growth rate of 8%.
All I’m doing here is extrapolating out the demonstrated dividend growth over the last five years into the next decade.
Is this unrealistic?
I really don’t think so.
We have a business growing a over 15% per year, and the near-term forecast is for more of that.
With the payout ratio being where it’s at, TSM is able to grow its dividend at least as fast as the business itself.
After the next decade, I’m assuming a slowdown of growth into a HSD area.
To be honest, I think TSM is capable of doing far better than my model and continuing the mid-teens growth beyond the next decade, but I do like to err on the side of caution.
The DDM analysis gives me a fair value of $288.77.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
My viewpoint is that this stock is priced far too cheaply for its quality and growth.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates TSM as a 5-star stock, with a fair value estimate of $262.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates TSM as a 4-star “BUY”, with a 12-month target price of $199.00.
My mark is the highest, but I’m also not that much higher than where Morningstar is at. Averaging the three numbers out gives us a final valuation of $249.92, which would indicate the stock is possibly 22% undervalued.
Bottom line: Taiwan Semiconductor Manufacturing Company Limited (TSM) is one of the most wonderful businesses in the world. Undisputed market leadership. Fat margins. High returns on capital. Gobs of growth. Fundamentally speaking, I can’t think of many businesses that have impressed me more.
With a market-beating yield, a low payout ratio, double-digit dividend growth, nearly 10 consecutive years of dividend increases, and the potential that shares are 29% undervalued, long-term dividend growth investors looking for more high-quality tech exposure who have a willingness to overlook some geopolitical risk should strongly consider this stock here.
-Jason Fieber
Note from D&I: How safe is TSM’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 70. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, TSM’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Disclosure: I have no position in TSM.
