By Goran Damchevski
This article was originally published on Simply Wall St News
Before getting into the performance metrics, we need to note that the semiconductor industry has been characterized by a chip shortage, for which analysts estimate a relaxation between July - August this year, but a possible persistence of the “crisis” until 2023.
Keep in mind that these are broad estimates and industry players such as Taiwan Semiconductor Manufacturing ( TWSE:2330 ), Intel Inc. , ( NASDAQ:INTC ), Infineon Technologies ( XTRS:IFX ) and others are increasing capacity in order to satisfy demand.
Looking at the situation, we ask ourselves, “ what is in shortage, and what is the cause? ”
It seems to be a broad spectrum of devices, from smartphones to electrical appliances, but the most demand comes from electrical vehicle and 5G infrastructure chips. The cause of the situation seems to be a mix of increased demand during the pandemic and a shift in the geopolitical field, including the US imposing limitations on Semiconductor Manufacturing International Corporation ( SEHK:981 ).
Thinking long term, we should ask ourselves, “ What happens when something is in high demand? ”
The answer is sometimes mixed. As we can see, competitors are provisioning capital in order to increase production capacity. It seems Taiwan Semiconductor M. is leading the increase with an announced US$ 100b investment over three years . This may not always be good, because if the situation is stabilized and demand returns to previous levels, the excess capacity will become a reason to drop prices and will result in reduced profitability. Capital-intensive businesses come with some fixed costs that are sometimes harder to shake off.
In this situation, companies are weighing the optimal investment that will sustain their value in the long term.
As for investors, we are probably going to see high levels of profitability, but should carefully analyze if the future profits are already priced-in in stocks. Keep in mind that this situation has been going on for a while, and the professionals are already in on the new projections.
With that being said, let’s analyze how Taiwan Semiconductor Manufacturing is performing!
We picked ROCE as a measure of performance because the business employs a good deal of both debt & equity.
Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns.
So when we looked at the ROCE trend of Taiwan Semiconductor Manufacturing, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Taiwan Semiconductor Manufacturing is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = NT$589b ÷ (NT$2.9t - NT$662b) (Based on the trailing twelve months to March 2021) .
Thus, Taiwan Semiconductor Manufacturing has an ROCE of 26%. That's a fantastic return, and not only that, it outpaces the average of 11% earned by companies in a similar industry.
See our latest analysis for Taiwan Semiconductor Manufacturing
TWSE:2330 Return on Capital Employed, June 2021
In the above chart, we have measured Taiwan Semiconductor Manufacturing's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Taiwan Semiconductor Manufacturing .
So How Is Taiwan Semiconductor Manufacturing's ROCE Trending?
Taiwan Semiconductor Manufacturing is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 26%.
The amount of capital employed has increased too, by 52%. The increasing returns on a growing amount of capital is common amongst high-performers, and that's why we're impressed.
The Bottom Line
All in all, it's terrific to see that Taiwan Semiconductor Manufacturing is reaping the rewards from prior investments and is growing its capital base. And a remarkable 329% total return over the last five years tells us that investors are expecting more good things to come in the future.
Investors should also bear in mind the possible stabilization of the competitive landscape and the normalization of prices. On the other side, if demand keeps growing, then the prices are likely to be retained and the valuation should increase even further.
A major piece of the puzzle is to analyze if there is still room left for exploiting this situation, or if the price has already surpassed value. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
