TSMC stock valuation -the supplier to Nvidia,Apple,Intel, AMD Explaining accounting terms in non-accounting language&Demand based valuation

Background: The semiconductor industry has been in the headlines since the covid-19 thanks to the increasing demand for electronics and gaming during the lockdown, the public and businesses’ zeal for AI (Artificial intelligence). I started to learn about semiconductor stocks by myself in 2018 when I was in college, but like most people today, my biggest challenge is that I know nothing about it, and I just put it off during that time. In 2020, I started to research Taiwan Semiconductor company after I had self-studied some valuation and gained some confidence from gaining 50%-300% in different stocks. The TSMC stock is traded at around $70 USD/Share during that time. But like most people and companies, I asked for advice from one of my mentors, who has worked as a consultant at IBM for over 30 years. I showed my valuation strategy in my previous stocks and brought up TSMC: Because TSMC has over 50% market share in the foundry market (I will explain later), making semiconductors for companies including Nvidia, Intel, Advanced Microdevices, Qualcomm, etc. If I can know how much revenue TSMC made from each customer, I can estimate TSMC’s growth rate based on these companies’ growth rates. But I don’t have that information. My mentor told me, “: I think you’d better focus on your current job to make salary. The stock price is affected by institutions with much more resources and analysts than yourself.” Like most people, I stopped studying the stock after talking with him. In the next six months, the TSMC stock has increased from $70 to $140 dollars. Like most people, I irrationally bought the stock at a high due to regret (when it decreased a little bit from $140) and didn’t know what to do when it started to decline further. Then, many things happened in the next three years. I had some unenjoyable interactions with JP Morgan Chase, as I mentioned in my previous post; I learned how institutions traded stocks (not value), I have valued several stocks, and investing has become my major job, my personal portfolio has increased from four digits USD to five digits and on the way to six digits, I self-learned about how to value technology companies like Oracle in my previous post. So, this year, I decided and finished the TSMC stock valuation. Plan of this analysis: Part 1. I will first explain the semiconductor industry and TSMC’s business model in plain language. You cannot forecast a company’s growth without knowing what it is doing, and you cannot understand what TSMC, Nvidia, and AMD are doing without knowing semiconductor. But don’t worry, everyone can understand if I can understand because I have no engineering or IT background. It is crucial for you to read and understand my explanation about the foundries business as it will affect estimation and forecast throughout this analysis. Part 2. Some readers have told me that it is still hard to follow my analysis without accounting knowledge. So, in the 2nd part, I will explain each single useful accounting term in the free cash flow model in a language that everyone with no accounting knowledge can understand. The forecasted revenue in the graph will be explained in part 3, as you will get bored easily if you read it first. Part 3. Then, I will teach you how to estimate TSMC’s future growth rate based on its customers’ demand Part 4. I will explain how traders (investment banks, equity research, private equity, asset management) price the company. Part 1 Semiconductor industry and TSMC business model What is a semiconductor?

From middle school or life experience, we learned that material can be divided into conductors and insulators based on how easily electric current passes through it. If we take people as an example, Joey Tribbiani in is like the conductor when it comes to dating while George Costanza in is an insulator.But most of us are in the middle, we hit on someone sometimes but not all the time. In the electric world, many devices need a material that can passes electric current but not “too well”. Electronics including cell phones, laptops, digital cameras, TVs, and washing machines all need semiconductors because they take users’ instructions, orders and communicate with different part by controlling the current flow. To make semiconductors, manufacturers chose silicon from the sand due to its stable structure(The sand getting your feet dirty when you go to the beach).

Normal People

How are semiconductors made? In this part, I will explain how semiconductors work by comparing the process of making bakeries, which are quite similar. (To save time, “chip” refers to the semiconductors.)

Manufacturers first heat sand to melt into a high-purity liquid and solidify it by crystallization. Like when you make candies, you heat sugar to liquid and put it into the mold. Slicing:

The silicon is solidified into a cylinder-like shape to slice into pieces of CD-like shape called Wafers. It is shaped in a circle just because doing so can transfer more information. (It is due to some complex professional knowledge we don’t need to know for valuation). It is like you first make flour into a dough and then cut into pieces.

Photosensitizing and exposing: When you make bakeries and want to have a special figure on it, using a mold to cover part of the bread or cookie is always easier than trying to add sugar or cream to make a specific shape directly.By the same token, chip manufacturers first cover the wafer with material sensitive to light based on their customers’ design. The design decides what devices can use the chips(laptops, cellphones, vehicles, etc.) and how much computing power the chip has(some laptops with high-end graphic cards can show 4k resolution while some 1080p). When light “strikes” the wafer, the light-sensitive material will thaw, covering the parts manufacturers want and leaving the parts without light-sensitive material unchanged. So these are some basic steps of making chips, but how does that affect the chip company valuations. Effects on financial valuation: In the semiconductor industry, there are two major kinds of companies. One kind is designing chips(like the executive chef deciding what mold to use when making cakes), while the other is making chips(like the assistant chef who prepares ingredients and does simpler work like cutting). With common sense, you can expect these two types of companies to have the following features and competitive advantages.

If you see the differences between chip design and manufacturing companies, you can understand why I bought TSMC stock three years ago. When I know little about an industry and buy stocks, I naturally select the one with a large market share and lower risk due to risk aversion. Buying chip manufacturing companies is unlikely to give you a potential return as hefty as a chip designing company, but it is also unlikely to make you lose as much as buying the chip designing companies. I am not justifying my irrational buying choice but just stating the differences. Now we know that chip manufacturing companies rely on market share, production efficiency, and demand from chip design companies, so let us factor these three value drivers into the valuation. Market Share In an industry with low entry barriers, a company beginning with a small market share can gradually grow to industry market share or even take more market share if its competitive advantage is high, while a company already with a high market share will gradually lose its market share. But in an industry with high entry barriers, major players can maintain market shares for years. Based on the graph below, I didn’t expect the TSMC to lose or grow much market share in the future.

(Source: Statista) Production efficiency Profit margin in finance refers to how much profit the company generates for each dollar or sale. There are three types of margins in accounting, as shown below: (The “Close Soon Store” is a convenience store I made up for illustration; you will learn more in part 2 below. Right now, you only need to know it is like a convenience store selling everyday products in a small town.)

I will explain in detail how to locate data, calculate and adjust the current profit margin, and forecast future profit margin in part 3. Right now, you just need to know that we will use the operating profit margin to forecast future earnings and subtract tax and interest expenses separately. By doing so, an unusual year with extremely high debt or surprisingly low tax payments will not distort the long-term forecast. For a trader in investment banks who prices (never values) the company, he or she is using the net profit margin since he or she prices the company based on EPS(earning/share)and price/earning, while the earning here is the net income. If the company takes a large amount of debt only this year, using the net profit margin and EPS will assume the company will take that debt every year. If the company pays billions of dollars for a lawsuit, using the current EPS will assume the company will pay billions of dollars forever. If the company has a sales slump due to COVID-19 or recession, using EPS will assume the company will never recover. I don’t price companies, but I will explain how traders price them in part 4. Demand To forecast future demand, I will forecast how much revenue TSMC’s customers (Nvidia, Apple, AMD, Qualcomm, etc.) will grow and how much wafters these customers will buy from TSMC for each dollar of revenue they make in part 3. Part 2 Free cash flow model and accounting terms explanation Each of my stock valuations ends with the Free Cash Flow model. The free cash flow projects a company’s future revenues, earnings, and how much cash the company generates after paying expenses and investments for the future. In contrast, traders at investment banks estimate the earnings a company makes. To explain the differences, imagine you are running a theme park. You sell tickets to visitors to get revenue and pay greeters, operators, and performers. At the end of the year, your revenue minus expenses is your earnings. But is that all the money you will have on your hands? No, you need to maintain or renovate the theme park every year; otherwise, it will quickly become too shabby to accommodate visitors. Every 3-5 years, you also need to add or replace games and facilities to keep its attraction. All these costs are included in free cash flow but not in earnings. The free cash flow model captures not only expenditures earnings do not grab but also benefits. Recently, I saw news that a woman returned a sofa she bought two years ago to Costco, and Costco gave the refund link. From an investment banker's perspective, the company has changed from making (Sales price minus Cost of Goods sold）to making nothing from the transaction. So, the earnings will lessen the differences. (I know a sofa costs a penny to Costco, but many people return daily.) So, from an investment banker's view, Costco is "a little bit worse off." From an accounting perspective, accountants will debit sales returns and credit the company's cash. After all, they care nothing but "keeping the balance sheet balance." But during the two years after making the sale, do you think Costco will leave that money on the company balance idly? Absolutely not. It has been used for buying inventory to make another sale or part of capital expenditure to open a warehouse. So even if Costco returned the original earnings after two years, it has generated values from those sales in these two years. And remember. The couch is just one of the millions of returns Costco handles. In this part, I will explain how to set up the free cash flow model. (Which items are included in the FCF model, and what data to choose for each item). The free cash flow model is universal in financial analysis. It is like Newton’s laws of motion in Physics. It is just a law of nature in finance summarized by people rather than some magic tools invented by people. So, if you see or hear someone claim they have a special way to analyze a company's financials, chances are they just make some modifications. It is like a priest telling people they have a more special message from God, but you can just read the Bible.

(Source: Professor Aswath Damodaran, NYU Stern) One question I have received from people with no financial knowledge is how to find information and data for valuation. So, in this section, I will explain and show how to locate, adjust, and estimate items in the Free Cash Flow model based on financial statements. When you decide if you should include an item in the Free Cash Flow model, always ask yourself: -Will this item affect the Cash flow? -Is this item a one-time charge/benefit, or will it incur every year or several years? -Will the amount of the item change, and by how much as the company grows, matures, and declines? To locate these items, we will start with accounting financial statements. People reading my post should know I have no good attitude toward accountants, so why do I still use accounting numbers? I once took a Roman history class in college and enjoyed it so much. My professor is so knowledgeable that he can speak and read fluently in Latin because many ancient documents are in Latin. But of course, he taught the class in English and explained it very well in his own words. So, my Roman history professor learned Latin, not necessarily because Latin is a good or bad language but because the document was in Latin. Then, teach it in English for students to understand. By the same token, I read financial statements in accounting language and explain them in human language. (The forecasted revenue in the FCF will be explained in the Growth rate estimation in the third part of this analysis. You can focus on understanding how to set up a free cash flow model right now) Disclaimer: I have been communicating with TSMC’s investor relations, and they have answered my email more quickly with more detailed and clear information than all other companies I have communicated with. (Most companies will not reply to my email). So, the following analysis only shows my opinion of the accounting firm rather than the TSMC. Net Change of working capital (NOWC) The net change of working capital is things companies need to hold for daily operations. To illustrate the idea, imagine you’re running a convenience store, and I just created a flashy name. The chart below shows what you usually need for daily operations. To run a store, -You need some cash for daily exchange. -You will also need various products: sodas, chips, milk, cheese, sandwiches, toilet paper etc. And you will need more than your monthly sale if you restock every month because you don’t want to have stockout when many customers come. -If your store is in a small town, you may mainly sell products to the neighborhood. Some are so familiar with you that they sometimes just come to take their regular purchase and pay you another day. The second and third items will reduce your cash flow in the short term because you purchased the product but haven’t sold yet, or you sold the product but haven’t been paid yet. But there are also items increasing your cash flow in the short term: -When you regularly buy products from the same supplier, they may allow you to take the product and pay them later. I recall that when some beer companies roll out some new flavor of beer, they will come to my mom’s restaurant and say, “You can sell it first to see how it goes and pay us later.” -Some people in the neighborhood will request some product that is hard for you to buy, and not many people buy. So, they will give you the money first and tell you to let them know whenever they are available. -If your store runs 24 hours, you will hire one or two other cashiers. He or she will work for you first and does not receive a salary until the end of the month. So, these are items you need for daily operation. The following chart shows the translation in accounting language.

So, the Net Change of working capital (NOWC) is the current asset – current liabilities from accounting statements. Because we subtract NOWC from the free cash flow, the increase in current assets will reduce free cash flow, while the increase in current liabilities will increase free cash flow. Attention!!-adjustment. However, we need to make two changes to the accountant’s statement. 1. Cash We include NOWC in free cash flow because it reduces free cash flow, so we should not include cash in current assets. This is important because you can largely underestimate a company if it has a significant cash balance. Many analysts underestimated Apple’s stock during 2016-2018 because they subtracted the 60-70 billion US dollars in cash and marketable securities balance from cash flow. (market securities are just financial assets a company can easily buy and sell on the public market, for example, US government bonds). 2. Short-term debt Another item accountants included in current liabilities, but I didn’t, is the Short-term debt. In accounting, a short-term debt is a debt that will be due within 12 months, while a long-term debt is longer than 12 months. So, suppose you take several loans to run your store. Would you like to include loans within 12 months in your daily operating calculation or calculate your sales and expenses independently and subtract the present value of all debts at the end? You will want the latter one because it shows a more descriptive picture of your daily operation. Because the short-term debt is recorded in the book value of the principal, subtracting that from your daily operation will add more noise when you judge your operation performance. (How well your sale is doing) In addition, since you will need to estimate future cash flow for the next 5-10 years and how much cash flow is worth today if the store keeps running, including current debt will distort your forecast. Including current debt in NOWC will assume you will take the same short-term debt for the same period, forever. But you are more likely to take short-term debt as you start up and grow while gradually taking less and less debt as your shop matures. In contrast, you can subtract the present value of all debt (regardless of short-term or long-term) from all operating assets the company expects to have at the end of the free cash flow analysis. TSMC’s NOWC Locate Each company has three financial statements: balance sheet (how much the company owns and owes at a point of time) income statement (profit and loss for a period) Statement of equity (how much equity-all assets less liabilities-left over for the company’s owners) The best way to access a company’s financial statements is to go to their investor relations on the company website. You can also check sec.gov(US Securities and Exchange Commission) for US publicly traded companies. The current assets and current liabilities are on the balance sheet, as the picture shown below: TSMC Current Assets and Liabilities (Accounting numbers)

It has many items, so a lean way to analyze them is to list each item and make your own judgment if it will affect operating cash flow by yourself.

(The number after each line item refers to the note # on the company report. For example, 11 after Heading financial assets means the Note 11 shows details of that line item.) Financial Assets/Liabilities You will see some items you are unfamiliar with, such as “Financial assets/Liabilities at fair value through profit or loss, financial assets at fair value through other comprehensive income,” etc. But don’t be nervous yet. I have taken two accounting classes in college and have a Bachelor of Finance and an MBA degree. But I will tell you I have NEVER learned or even seen these items during my education. But I can do my research, and I found these items are merely accounting language of financial assets. Returning to our store owner scenario, these items are like a store owner who also owns some stocks and bonds in the public market. When you own stocks, you will have unrealized gain or loss when the stock price moves if you don’t trade the stock. Those “Financial assets” line items are like changes in your stock portfolio. You will not include your stock portfolio to evaluate your convenience store performance. In the same way, you will also exclude these financial assets or liabilities from the NOWC calculation for free cash flow. You may wonder," But the company does own or owe these financial assets. How could you estimate the company’s value without counting them?" I will count, but I don’t have to mingle them with operating cash flow. After I estimate operating assets, I will estimate the value and performance of these financial assets separately. In the close-soon store example, the store owner can calculate the percentage of his assets in stock, bond, and store, respectively, and return on each. Other Financial Assets The last current asset item is the “Other Financial Assets.” I usually first ctrl+F the item on the company’s financial report when accountants report something as others. Note 36 shows that Other Financial Assets are mainly collateral for production. Collateral for operation is a typical item reducing free cash flow. However, the current asset on the balance sheet above shows the company has 25964.4 and 16630.6 million NT for 2022 and 2021, while Note 36 only explained 210.2 and 129.1 million NT. (NT is the New Taiwan dollar). So, how much should I subtract from Free Cash Flow? I can ask the company’s investor relations, and TSMC has been replying to my questions promptly and considerately. However, in my years of valuation, only two companies (TSMC and Costco) have done so. Other companies usually do not reply to me or transfer me to lawyers who confuse me. So, I started estimating the financial assets included in NOWC while waiting for TSMC’s answer. This step is important as you are unlikely to get all clarification from the company you value, and trying to estimate by yourself will sharpen your skills for future uncertainty in valuation. One mistake many new investors, including previous me, made is trying to include everything from the financial statements in the free cash flow because they are worried about missing anything. However, some items either do not affect cash flow or have few effects, and spending time on them is unnecessary. So, before I try to estimate the other financial assets, I take a look at how much the other financial assets affect the NOWC and free cash flow. As you can see from the picture below, the median NOWC/Sales (how many percentages of sales revenue are NOWC. I calculate percentages so that I can estimate future NOWC easily) is -8.61%, including the total Other Financial Assets, and -6.34% excluding the total Other Financial Assets. A negative NOWC means an increase in free cash flow. A 2% of revenue has few effects on the overall valuation. What if the number is very different? Then, I can check the past decade of annual reports to see if the Other financial Assets are recurring every year. If yes, I can estimate the NOWC and FCF cash flow in a range rather than a fixed number. So, if Other Financial Assets are about 10% of NOWC every year, then I can estimate the Free Cash Flows when I consider 0% of Other Financial Assets, 5%, and 10% as NOWC with scenario analysis and get a range of stock price rather than a single number. However, I may not include them in the reinvestment rate as that will overestimate the growth rate. But if I see a line item unclear, like Other Financial Assets under current asset on a company’s financial assets, which comprises 50% of the NOWC every year, I will include that as NOWC and reinvestment. That means accountants have unintentionally (or intentionally) misclassified some items. Other Financial Assets’ effect on TSMC’s NOWC

I got a reply from TSMC, as shown in the picture below, and based on the description, I will exclude the Other Financial Assets from the NOWC since it does not affect the operating cash flow, and I will calculate financial income and expense separately later.

Accrued profit-sharing bonus to employees and compensation to directors and supervisors Accrued means the opposite of prepaid in accounting. Go back to the CloseSoon store example. Suppose you hire a manager to manage your store. You told him you would pay 5% of all your additional after-tax earnings growth over last year, and the payment would be made at the end of the year. Now it is June, and the 5% of all after-tax earnings from January to May you have not paid to your manager is the accrued profit-sharing bonus to employees (some companies may also call it salary payable). Should you include it in Free Cash Flow? That depends on whether the payment to your manager is all in cash, even if it is one of the current liabilities. Because the current liabilities we included in NOWC are those that will increase free cash flow, you can spend the accrued bonus in other places and pay later if it would be cash payments. For example, you can use the bonus payable to your manager to lease an ice cream machine in Summer. After the summer, you return the ice cream machine, make additional income from selling ice cream with fewer leasing fees, and don’t need to pay your manager’s bonus until December. But in large companies and corporations, employee bonuses and compensation can be other than cash. Many companies can give employee stock options as a bonus (i.e., a company can give a manager stock option to give the right to purchase the company stock at $20 dollars/share. If the company stock is traded higher than $20 dollars/share, for example, $50 dollars/share, the employee has the right to buy at $20 dollars and sell at $50 to make capital gains). In the Closesoon store example, a stock option is like giving 1 or 2% ownership of your store to your manager. If that is the case, the bonus is no longer part of the operating cash flow but a % of the claim on your store. In that case, you will calculate all operating assets first, less the total debt, and multiply the result with 1 or 2% as your manager’s ownership. TSMC accrued profit sharing bonus

Based on the picture above, TSMC only pays bonuses to its directors when they make money and only pay little. (I am not sure why it says “not more than 0.3% and not less than 1%” rather than “not less than 0.3% and not more than 1%) but I don’t worry much as it is very small.

If you see the items under “Employees benefits expense summarized by function” in the graph, the “recognized in cost of revenue” and “recognized in operating income.” are accounting languages and means accountants have recorded these employee benefits as operating expenses in the income statement. If the payment is made in cash, I don’t need to worry about that. Because I forecast future revenue growth, I estimate future operating profit margins (operating income/revenues) when I predict future cash flows, the operating profit margin will incorporate the accrued profit bonus. However, if the payment is made in the stock option, I need to add back the expense and value the present value of the stock option individually. In contrast, investment bankers and traders will add total stock options to shares outstanding and calculate price/(shares outstanding+stock option). The issue for such action is it assumes that all stock options will be exercised at today’s stock price. However, employees will only exercise if the market stock price is higher than their strike price(the price they have the right to buy). But based on my communication with TSMC investor relations shown below, I can use the estimated operating profit margin to incorporate those expenses and will not include this item in NOWC and FCF. Why? Remember that we include current liabilities in NOWC because it increases the company’s free cash flow, while the accrued profit-sharing bonus is something that the company has the freedom to pay or not. The company does not get additional cash flow for having bonuses payable to its directors and managers. Accrued expenses and other current liabilities. Another item I am not sure about is the “Accrued expenses and other current liabilities.”.I searched those items with ctrl+F in the company 10k and got the following results:

The accrued expenses and other liabilities include: 1. Revenue Recognition. 2. Current Lease liabilities 3. Contract liabilities 4. Current temporary receipts from customers 5. Refund liabilities Let us evaluate the effects of cash flow one by one. 1. Revenue Recognition In Accrual accounting, a company earns revenue when the product is delivered or the service is performed. So, if a regular customer gives you the money on Monday morning when he goes to work and tells you that his wife will take the organic eggs this weekend for their family party, accountants will record the money you receive as “unearned revenue” liabilities. We don’t need to include this item since we have incorporated the total sale revenues and operating income into the FCF model. 2. Current Lease liabilities If you don’t own the property to run your store, you will lease it and pay annual rent. Some leases may require signing for at least 3-5 years. In accounting, they record leases within 1 year as current lease liabilities and those longer than 1 year as non-current lease liabilities. Now, think about what your lease liabilities will change if you make $40k a year from your store. How about if you make $80k? How about if you lost money last year from your store? Your lease expense will not change. Your landlord will not charge you less because you are making less money and will not charge you twice if you make twice the income. So, I regard lease liabilities as debt because it is something you need to pay anyway, and you will get in trouble or at least must reduce other expenses if you fail to pay. So, I will exclude it from NOWC and operating cash flow calculation but consider it part of the debt, calculate the debt value of all leases (not only for the current year) later, and subtract the total debt value from operating assets. To learn more about how to calculate the debt value of a lease, check my previous post at link by searching for “Leasing”. 3. Contract balances As the b. in the picture above shows, this item is like your frequent customer paying you a one-year fee to receive and deliver a daily magazine for him or her. In the middle of the year, you have a “half-year delivery obligation” left to perform, but you have received the one-year fees. So, it increased your free cash flow, and we will include that in NOWC. 4. Current temporary receipts from customers As the c. in the picture above shows, this item is like your frequent customer lending you some money to work extra hours during the summer because they may have kids coming back and need to buy more products more frequently. I doubt the company is allowed and feels comfortable using customer deposits for other business purposes. And since it only occurred in 2022 and 2021 in the past ten years, and the amount is small, I decided not to include that in the NOWC calculation. (I tried to include and exclude this amount, and the NOWC/Sales ratio changes from 6.7% to 6.3%, so I don’t need to worry about it that much). 5. Refund liabilities As the c. in the picture above shows, this item is like that you estimated some customers may return some products you sold. But I don’t think you will need to set aside a specific amount of cash that you can use for other business purposes for returns. So, I will not include it in the NOWC and operating free cash flow. Cash dividends payable and income tax payable. Cash dividends payable. While the company is free to pay dividends or not, very few companies stop paying dividends if they have a history of paying it, even during the pandemic. Investors and the market generally take stopping paying dividends as a signal that the company is in trouble. Such an implicit association is one of the reasons many high-growth technology companies today prefer stock buyback to pay dividends. You can check my previous post if you want to learn more about the differences. However, since an equity investor either owns part of the company’s equity (free cash flow less expenses and debt) or receives the dividends, there is no need to include that in free cash flow. Income tax payable Some companies can have additional cash flow in the short term by recognizing a deferred tax. Some government policies may give companies tax credits to facilitate growth or attract foreign companies. But those benefits are usually not sustainable. So, I will not include the NOWC and FCF cash flow. However, some governments do give companies such as renewable energy and electric vehicles a 5-10-year tax credit, and the US government is expected to release some grant bills for semiconductor companies. However, I prefer to estimate those tax benefits individually at the end rather than including them in the NOWC calculation. Otherwise, I will mistakenly include the tax benefit forever because the free cash flow model assumes an ongoing basis. TSMC NOWC (Net Change of working capital) rate. With this information, I calculated TSMC’s past ten years’ NOWC by excluding items on the balance sheet that do not affect operating free cash flow, as shown below.

Now, the question is how to forecast the future NOWC. Many people avoid stock investment and claim that “No one knows about futures.”. It is true, but I only need to estimate rather than get the exact same answers. Back to the Closesoon store example, a convenience store can have different amounts of products sitting on shelves or money owed to suppliers every year, every month, and even every day. But that amount should not change dramatically. So, I calculate the NOWC/Sale revenue to estimate future NOWC based on my predicted future revenues. I have confidence in my number because it implies that a company’s NOWC changes will be proportional to its sales revenues. In the store Closesoon store example, you will prepare more products on shelves if there are dramatically more people coming to your store, and you can take more products from your supplier than before and pay later. TSMC NOWC rate

(A negative NOWC means increasing free cash flow) Attention!!: While some companies like Walmart can have negative NOWC for decades due to their marketing power, negative NOWC means selling products on credit and is not sustainable for most companies as they mature. In the Closesoon store example, the owner can take an increasing amount of product to sell first and pay later. However, if the owner gets older, he may become half-retired and not care about the store’s sales that much anymore. Consequently, suppliers may also reduce how many products they can sell first and pay later. The negative NOWC will gradually become zero or even positive. A zero NOWC does not affect free cash flow, while a positive NOWC will reduce free cash flow. For most companies you analyze, you may gradually increase the NOWC/Sale ratio to the industry average if it is negative or zero. While investment bankers and traders also use industry averages in their pricing, I only use them as the company matures. My logic is that a high-growth or efficient company with good management, advanced technology, and a strong brand name should have a lower NOWC than the industry average. However, the company will become as mediocre as the industry average as it matures, just like many superstars in sports. Many great NBA players started their rookie careers with breaking a series of NBA records, and some players like Shaquille O'Neal even broke the basketball board. But as they passed 30-35 years ago, they gradually became substitutes or even benchwarmers. Companies also have similar business cycles. However, as investment bankers and traders do, using the industry average for all companies will fail to differentiate star companies or declining/troubled companies from others. It is like using NBA average performance to estimate a new draft. As the picture shows, TSMC has a negative NOWC, implying an increased free cash flow. But if you check the data before 2019, the company has a close to 0 NOWC rate. It is more likely that the negative NOWC rate is due to the semiconductor boom since COVID-19 and the business’s zeal for artificial intelligence. The industry average NOWC/Sale ratio for semiconductor companies is 22.4%. I don’t think TSMC’s NOWC will increase that much since it is the largest semiconductor foundry company, and the technology has a high entry barrier. So, what should I do? Back to the Closesoon store example, a 0 NOWC rate means the time it takes to receive payment for products you sold is roughly equal to the time it takes to pay your suppliers. While that is unlikely for a small convenience store, it is possible for TSMC with its market power. I know you probably still feel unsafe to set it to 0 over time, and so do I. So, I collected many companies similar to TSMC and calculated the industry average NOWC rate. The 22.4% industry average NOWC/Sale is the data I got from the NYU Stern Dataset, including all semiconductors companies such as Nvidia, Intel, AMD, Qualcomm etc. Recall I mentioned in the business model section that TSMC specializes in making foundries and will have a different production line from those designing semiconductors. The graph below shows the top 10 semiconductor foundry companies ranked by market revenue, and I decided to calculate the industry NOWC/Sale ratio with these ten companies. One concern is whether ten companies are too small a sample size. Usually, I will try to collect 20-30 companies to be representative if I want to estimate a ratio for an industry, although I have seen some college professors or Ph.D. students use a 5 or 8 sample size. It is like asking for five people’s salaries, calculating the average, and claiming it is your city’s salary average. The sample size is too small to represent the population. However, the semiconductor foundry industry has limited players and high upfront costs to startups. So, I think the top 10 companies will be representative. However, TSMC has had over 50% market share in this industry for years. I can predict without even trying calculation that the result will be close to TSMC’s NOWC/Sale ratio due to its large weight. So, what should I do?

As the graph shows below, I calculated the industry average NOWC rate for foundries when they included and excluded TSMC as the sample, respectively. As you can see, the TSMC has significant effects on the result, reducing the industry NOWC/Sale ratio from 6.77%-9.22% to close to 0. So, even if you want to use third-party data sometimes, be careful how they collect and calculate it. An investment banker can compare a technology company to the NASDAQ index to show “lower risk” if they want you to buy the company and compare “SP500” to show “higher risk” if they want you to sell. I found that when I used the Bloomberg terminal(a super expensive machine traders use in institutions) in college. You can cook the data without even realizing it. (Some companies only have records from 2022 to 2018, so I calculate the rate for all companies between 2022 and 2018 and all available data between 2022 and 2013. I also adjusted data from Samsung by multiplying Samsung’s total NOWC with how many percentages of its revenue is from semiconductors because Samsung sells not only semiconductors). TSMC Industry NOWC rate

Action time: The industry average NOWC/Sale ratio, including TSMC as the sample, is 0.04%, while excluding TSMC is 5.78%, and the TSMC’s median NOWC/Sale ratio for the past decade is -6.34%(negative). Which rate should I use? I use the average of 2.91% (the average of 0.04% and 5.78%) as the year ten and after NOWC/Sale ratio for TSMC, then gradually increase the current -6.34% rate to 2.91% as the FCF model shows. By doing this, I expect that TSMC will have increased cash flow from NOWC for several years, but those strengths will decrease over time, and NOWC will start to reduce its cash flow in the year 9 and 10. However, TSMC’s NOWC will not reduce its cash flow as much as mediocre semiconductor companies. One counterargument is how I can be sure. I am not sure, I am never sure, and I don’t need to be sure. Back to the CloseSoon store example, you don’t have to know exactly how much product you will carry each year, each month, and each week, but you just need to know a ballpark. In some months, the actual number will be higher than your estimate, but it can also be lower in others. TSMC future NOWC estimation But if you are valuing a company with few competitive advantages or in a business with many companies that is easy to enter, you probably need to gradually increase the NOWC/Sale to the industry average rate. If you’re valuing a convenience store in a small town where the owner has to drive to the bigger city to buy inventory, then the NOWC/Sale ratio will be higher than the industry average because he needs to buy more inventory each time to save transportation costs. You need to do these works in investment analysis rather than simply filling the formula. Not only accountants but even AI can simply fill the data into formulas. I calculate and estimate R&D and capex ratios in a similar way. To learn about how to adjust R&D, please read my previous post. It is crucial to adjust R&D, but I have covered this in my previous post(search “R&D expenses, Amortization R&D expenses"), and explaining again here will be wordy. With this adjustment, I set up the free cash flow for TSMC. I know you probably want to leave the post right now and wait for $60 dollars to buy TSMC. But you haven’t learned how to estimate future revenue and operating income. And it is the intrinsic value, how much the company is worth, while you haven’t learned when to sell. To know how, keep reading below.

Part 3 TSMC Growth Rate Calculation I started my every stock valuation by reading the annual report on the investor relation part on a company’s website. On page 13 of TSMC’s 2022 annual report, I found this information:

If I don’t know which company contributes to TSMC’s revenue most, I can use the average growth rate for these companies. But that will underestimate the stock value if most of TSMC’s revenue is from Nvidia or AMD or overestimate if it is from companies like Intel. Using industry average will also give me few upper hands as traders in institutions always use that. Then I just googled TSMC’s top 10 customers and got the result in Figure below. The problem was resolved in one click, and I had procrastinated on the valuation for the past three years due to uncertainty and my IBM mentor’s advice.

But what if I cannot get the result online? In fact, I first get these clues from reading TSMC’s annual report rather than searching. Page 7 of the TSMC annual report shows the following information. So, I read TSMC’s annual reports for the past ten years to see if the revenue distribution is sustainable. From my experience, if you value some companies and find out that the recent annual report does not disclose enough information. Try to look at older reports, and you will always have some surprises.

The figure below shows the percentages of TSMC’s revenue from its top 1, top 2, and top 10 customers. And everyone knows that the top 1 is Apple. If you are valuing a company and encounter such a situation, you can still estimate even if you don’t know all ten customers. You can set the 23% TSMC’s revenue growth rate dependent on Apple, then check the industry average growth rate, and then you make the rest of 73%, starting from a high growth rate but gradually reducing to the industry average. I will explain more in detail later in this post.

Now, If I can estimate the growth rate for these companies for the future, I will also be able to estimate the TSMC’s growth rate. However, I shouldn’t just use the weighted average growth rate of TSMC’s customers as its growth rate. Recall that the growth rate depends on: How much the company reinvest its operating income (reinvestment rate) And How well it generates return from its investment (return on capital). If I use customers’ growth rate as TSMC’s growth rate, I will assume that TSMC has the same reinvestment rate and return on capital as Apple, AMD, Nvidia, etc. The solution is to estimate the “cost growth rate” for TSMC’s customers. In other words, I will estimate how much each customer pays to TSMC and how that cost will increase in the future. But I should not just use the growth rate of things like the cost of sales/cost of goods sold as the TSMC growth rate because not all companies’ costs will necessarily go to TSMC. For example, Apple’s sales cost includes parts for iPhone, iPad, MacBook, and services, but TSMC’s semiconductor is just one of Apple’s parts. In addition, some companies have more than one semiconductor supplier. Recall that I explained in the business model part that TSMC specialized in the Wafer process in the semiconductor production process. So, if I know how much growth each company spends on Wafer supplies, I can estimate TSMC's growth. I checked TSMC’s customers’ 10k annual report, and coincidently, I always got some information from each company. The following text is an example and shows AMD's (Advanced Micro Devices) reliance on TSMC for wafers. I know that the text shows that AMD also relies on other wafer suppliers, but my research shows that TSMC’s chips are more advanced (from 3nm,5nm7nm to 10nm)and expensive than other suppliers, so I feel ok to use the growth rate of a company’s wafer supplies. (The smaller the nm, the more difficult to produce)But it is also case by case. For example, Qualcomm, another of the top 10 of TSMC’s customers, has TSMC, Samsung, and Global Foundries as its major wafer suppliers. Then, I use the ratio of these three companies’ revenues in the past ten years to estimate how much percentage Qualcomm pays for each company because Global Foundries is much smaller than the other two companies, while Samsung has a similarly advanced semiconductor as TSMC. The Figure below shows AMD’s unconditional purchase commitment (which means they usually cannot cancel the order) for wafers. AMD commitments

I collected the commitments each year and calculated the commitment/annual revenue for AMD. I can roughly estimate how much TSMC’s revenue is from AMD. While not all AMD’s commitment is from TSMC, I can calculate the percentage growth rate rather than a fixed number. You may wonder how I can locate the commitments in AMD so easily when I do my valuation. I am able to locate them simply because I have read so many 10k annual reports for different companies that I started to familiarize myself with accountants’ languages. Usually, for contracts with suppliers, they will use terms such as “commitments,” “purchase obligation,” “contractual obligation,” etc. The Figure below shows that for each dollar of AMD’s revenue, 0.076 dollars go to buying raw materials from TSMC and other foundries. The result makes sense since the cost to produce each unit of AMD chips will be relatively stable while AMD sales are up and down. Estimated TSMC supplies as ratio of AMD.

The next step is to estimate the future growth rate for AMD each year for the next ten years with AMD's reinvestment rate and return on capital. Once I get the AMD future revenue each year, I can multiply the result by 0.076 to estimate the unconditional purchase commitment of AMD for each year in the future. But not all AMD’s unconditional commitment is from TSMC. I will use the revenue ratios of TSMC and AMD’s other customers in the past ten years to estimate how much AMD’s unconditional commitment goes to TSMC, just like I did for Qualcomm above. Recall that my challenge earlier is to avoid directly using TSMC’s customers’ (such as Apple, AMD, Nvidia, etc.) growth rate as its growth rate. However, since different companies have different unconditional purchase commitments (or purchase contracts/obligation)/sales ratios, the law of large numbers in statistics helps me even out the effect. (For example, Meditak has 0.25 TSMC supply/Meditak revenue ratio, while AMD has 0.076) I did the process for all top 10 TSMC customers to get the total estimated purchase of these companies from TSMC. However, the top 10 suppliers only represent about 53% of TSMC’s sales. So, I cannot directly use the result as TSMC’s future revenue. Instead, I will calculate the growth rate of the total expected top 10 customers payment (unconditional purchase commitment) and estimate the growth rate of the left 47% TSMC’s revenues (using things such as the industry average). The weighted average for these two results is the estimated TSMC revenue growth rate. By doing so, I can estimate TSMC’s growth rate even if some of TSMC’s customers have foundry suppliers other than TSMC. Then, I used the growth rate to estimate TSMC’s future sales revenue based on the most recent TSMC revenue and adjusted TSMC’s profit margin, which I will calculate later. By doing so, I will factor TSMC’s profitability with the sales growth of its customers. As you can see from the figure below, I estimated that all TSMC’s customers’ payment to foundries will grow about 10% to 8% and gradually decrease to equal and then less than the overall economic growth rate. Example of forecasted customer revenue and TSMC’s revenue growth rate from Nvidia

Estimate payment of TSMC’s customers to its foundry suppliers.

(Although not all foundries are TSMC, we can use the customer demand growth rate rather than numeral value) With the estimated growth rate, I forecasted TSMC’s future revenue. You will see that I separate revenue estimated from Apple, MediaTek, and Adi from other customers because Apple’s purchase commitment will include not only semiconductors but also other parts(calculating Apple’s total cost to suppliers will overestimate); Mediatek just requires more work and Adi has limited data so I have to try other methods. Forecasted TSMC revenue growth rate

Operating income margin adjustment

Parent vs consolidated income The graph shows the “parent only” statement of comprehensive income. For some companies you value, you may see some financial statements titled “Consolidated statement of comprehensive income, Consolidated balance sheet”. To explain the differences, let us return to the Close Soon Store example. Suppose you are the store owners, and now your son has grown up and plans to open a store in another region of the town. Because he just started, you decided to help him by offering $25000 and taking 49% of his store ownership, and he paid the rest with his savings and borrowings. You receive 49% of his after-tax earnings at the end of the year. If you are an accountant with a CPA, you are required to record in such way: How accountants record the Your Son’s store on the Close Soon Store

Sounds makes sense, right? Although I will explain why it does not later. But now, suppose you own 60% (over 50%) of your son’s store; then the CPA will record that on your financial statements as follows: How accountants record Your Son’s store on the Close Soon Store (if you own>50%)

In accounting, they call the process “Consolidation”. What are the issues with these accounting records? 1. We start free cash flow valuation with the company's operating income. So if you own 60% of your son’s store, you will include all their income in as your operating income to forecast your store while you only own 60%. 2. You will also consider 100% of your son’s debt as your store’s leverage. So, you will overestimate your operating income and debt. But these are not the most destructive effects. The biggest problem with doing these is: You assume your son’s store will perform exactly the same as yours! The solution is to value your store’s value with your own store’s operating income and debt only, then your son’s store’s value with its own operating income and debt only, then you add the 60% of the operating asset of your son’s store to yours. That is why I started the operating income adjustment by using TSMC’s parent-only operating income rather than the consolidated income. But I can do that because TSMC has responsible financial departments. When you value a company with many cross holdings and subsidiaries, 9 of 10 will show consolidated financial statements only. Then you have no choice but to estimate the value of each subsidiary by yourself, and some companies can have over a hundred subsidiaries.CPAs may claim that consolidation is the accounting law requirement and shows the company's overall picture. But no one tells them that they cannot provide both consolidated and parent-only financial statements like TSMC did. They just don't do that because they are either too lazy or don't have enough intelligence to estimate parent-only asset value. Add back debt and non-cash items. Lease expense I have explained in Part 2- Current Lease Liabilities why we should treat leases as debt rather than operating expenses. So, I add back lease liabilities to the operating income calculation here while subtracting all lease debt at the end of the valuation. Doing so will give a more reflective picture of how profitable the company’s operation is. Back to the Close Soon Store example, if you include your rental expense to forecast your future operating income, you will assume your rent will be doubled if your income doubles. Of course you will include rental payment as your expense, but not at this moment. Adjusted TSMC’s operating income and margin

Amortization of intangible assets Intangible assets are assets without physical substance and expect to give the company future economic benefits, such as brand name and patent rights. Amortization of intangible assets refers to the process where this economic benefit will decrease to nothing over time. I don’t need to include it in Free cash flow model since the company does not pay real cash, and I have incorporated the “reducing benefit over time.” when I set the growth rate to reduce to the overall economic growth rate as it closes to year 10 in the graph ”Forecasted TSMC Revenue Growth Rate” above. Take the Close Soon Store example; some neighbors will keep shopping at your store over others because some have grown up shopping there, or many have developed close friendships with you. But as you age, young people move out of the town, new stores open, and your “competitive advantage of acquaintance” will wane. Some intangible assets may do give you some potential benefit, but you need to estimate them case by case. For example, Mickey Mouse and many other cartoon characters are Disney's intangible assets. To estimate their value, you can check how much Disney theme parks and films can charge over a mediocre theme park or cartoons and estimate how long. Another extreme example is that the Ohio State Univesity trademarked the word "The". Then you can estimate how much additional benefit the university can make from the "The." I think it is almost 0 unless some paranoid people apply to the school or buy its shirt just because it has "The" on it. It is like someone trademarked"Water". What are you going to do? Are you going to sue anyone who uses the word "Water"? In that case, you can still estimate how much OSU spent on getting the trademark, how many additional paranoid people will apply to the school or buy the shirt, how likely OSU will sue other schools for using "The," and how much litigation payment they will get. You can not just use annual admission growth to show the effects of the "trademark," as the increasing admission can be due to many other reasons. It may be because OSU does not have enough money or more bachelor graduates cannot find jobs applying to its graduate school. (It is hilarious that while I was writing this article, even Grammarly suggested removing "the" in front of the Ohio State University). (Please search R&D in my previous post to learn how to adjust R&D expenses. I did not include this post to stress more important content) Result: As you can see from the graph, the median operating profit margin increased from 38.92% to 42.32%. The 3.89% “efficient margin improvement” is how TSMC improved its margin over the years. The 19.72% industry operating income margin is the average operating income margin of all semiconductor companies. Traders, investment bankers, and asset managers usually use the 19.72% for all companies. As shown below, I set the TSMC 2024 unadjusted operating margin to 50.89% (48.82% unadjusted operating margin in 2022*(1+3.89%) efficient margin improvement). I expect TSMC to improve its operating margin for three years, then gradually decrease to 19.72% of the industry's average operating margin over time. By doing so, I incorporated both TSMC’s current efficiency and the effects of the business cycle. A company’s business cycle is like a person’s life. A person is born, grows up, matures, ages, and then ends up in heaven or as a senior accountant or investment banker. The company also has business cycles of startup, growth, high growth, mature, and decline. Forecasted TSMC Margins

Estimated TSMC’s subsidiaries’ value

TSMC revenue with and without subsidiaries

After calculating the future operating asset, I add the TSMC’s ownership % multiplied by the value of each subsidiary. For companies with financial statements, I value each company like I did in this post. For companies with no financial statements, I priced them like traders or investment bankers. I will explain how to price in part 4. Some TSMC subsidiaries, such as TSMC Arizona, China, Nanjing, and Global, are just TSMC offices in other countries for customer service or support. Since the consolidated revenue(revenue including subsidiaries) has less than 1% more revenue than the parent only, I just multiplied the total operating*(1+0.82%) as I don’t think it is worth valuing them. Then I add the market value of debt I calculated, cash and market securities the company owned from the most recent balance sheet, divided by total shares outstanding. I calculated the TSMC intrinsic value on NYSE (how much the stock is worth) as $58.31/Share. If I don’t own TSMC shares now, I will only buy them when they decrease to this amount. But since I have bought many TSMC stocks on hand, I am unlikely to buy more unless it goes really low. Should I sell it because it is overvalued now? Well, I buy stock at intrinsic value since it is how much I believe it is worth, I need to estimate how much traders and investment bankers price them to decide when to sell. If you check my previous investment in Facebook(Meta) here, the traders helped me buy the stock at $190 and sell it at $470, while I think it is worth $320-$370. So, knowing how traders behave can help me scale up my capital gain. Part 4-Trader/Investment Banker pricing To explain how traders price companies, I will use two other real-life examples. I have been traveling in Mexico, and my house is about a 10-minute drive from Costco. But in the opposite direction of my house to Costco, I found many convenience stores near the villa area selling Costco Kirkland paper towels as well. So, these convenience stores are reselling paper towels they bought from Costco to travelers living in the villa. Now I want you to think. Do you think these convenience stores will set the Costco paper towel price based on how much they bought from Costco and a fixed margin, or how much other convenience stores near the villa area set? A rational convenience store owner will set the price based on other convenience stores, and the fewer convenience stores nearby, the higher the price they can charge. If you are thinking, how much difference could it be? I can give you another example. My relatives used to buy electronic watches in Hong Kong and resell them in Guangdong, China in the 70s. The driving distance is about 27km (16 miles). In Hong Kong, you can pay 100 HKD to buy “one hand” of electric watches, which means you just use your hand to grab as much as you want from the bags and 100 HKD each time. Now I want you to think, do you think my relatives will resell the price based on a margin of how much they bought? Or how much do other traders set? My relatives resold 100HKD for each watch because China was in a centralized economy during that time and did not allow private ownership so there are no electronic watches produced in China. The business collapsed after China joined the WTO and allowed capitalism because the free market reduced the price differences. This is how traders work. Price a company based on how much other traders price. But you may wonder then why bothers to value a company rather than pricing a company like traders? Many people don’t believe they can beat the market because they think market prices are manipulated by traders in institutions (investment banks, asset management, hedge funds). There are two reasons why value companies will beat the traders: 1. Stock markets like NYSE or NASDAQ are comparatively free markets. Billions of buyers and sellers can participate and can public information to value. So, these stock markets are not like limited convenience stores near the villa area in Mexico. 2. Traders price the company based on what other traders price. As a result, they usually collectively overestimate or underestimate a stock. You don’t believe? Then, keep reading below. P/E ratio-the thumb of the rule of traders keeps changing. When traders price a company, they will collect many similar companies in an industry. For example, they collect Nvidia, Intel, AMD, etc, to price semiconductor companies.

Then, they use it to get the P/E ratio(P/E). Then, they forecast a company’s next quarter or year earnings and multiply them with the P/E ratio. Go back to the electric watches example; the p/e ratio is like 100hkd/hand. So, for traders, a stock is cheap with an $18 P/E ratio if the industry average is 30, and a stock is expensive with $40 P/E. In the past, I used analyst forecast P/E to price my company after the valuation. However, the following picture shows NASQA’s estimate for TSMC’s P/E. Check the number. If we use NASDAQ P/E, the TSMC stock can range from $140/share to $7 dollar per share. I don’t know how do you feel, but I feel it is like I ask someone how much he or she made a year, and he or she said he or she made between $5k to $100k. He might not be lying, but it really tells me nothing.

My next solution is to use the P/E ratio from New York University Stern Business School. Its data are from at least 50-60 semiconductor companies. The picture below shows pricing for TSMC stock based on NYU’s P/E ratios for the semiconductor industry. The trailing P/E means the P/E based on the past 12 months, the forward P/E is analysts’ forecast for the future P/E ratio, while the Aggregate is to add up market capitalization of all semiconductor companies in the sample and divided that by net income for all money-making semiconductor companies. If I completely believe in NYU, I should be happy and wait for my TSMC’s stock to go to $300-$600 to sell. However, my life and investment experience told me that it is important to be calm not only when I have negative but also positive feelings. While I did learn a lot from NYU, I can not only count them for two reasons. 1. Counting NYU’s number only will put my asset value at the mercy of NYU’s data. In addition, the time they updated the data may differ from when they published. Like someone who hands over their assets to banks or asset managers, but no one ever told them what if banks are wrong. 2. I like and think it is right to take credit and responsibility for my own actions. Pricing based on NYU stern data

(Trailing, forward aggregate P/E are from New York University Stern Business School) So, I decided to calculate the semiconductor industry P/E ratio by myself. To calculate the P/E ratio, I just need the company stock price, which I can download from Yahoo Finance, and the company’s annual earnings per share, which I can get from the U.S. Securities and Exchange Commission (Sec). Both are public information. To reduce the short-term volatility effect, I calculate the median stock price for each year and each stock in the sample in the past ten years.(Excel tip: Using the freezing panel can keep the year showing on the top as you scroll up and down) The picture below shows the P/E ratio I calculated for 32 semiconductor companies in the past ten years. The median P/E for all companies is 17.72, and the average P/E is 31.93. The median P/E for all Money-making companies is 20.57 and the average is 36.94. Should I use the 20.57 to price the TSMC to estimate traders’ pricing? Semiconductor industry P/E

Look through the graph, and you will find several things. 1. Many stocks’ have extremely volatile P/E. For example, Nvidia has around $4 P/E before 2017,$8-$15 before 2021, and $44-230 in the past three years. 2. An interesting fact is that if we follow the traders’ logic-a company with P/E higher than industry average is overvalued, we should never buy Nvidia since 2021. We probably should buy TSMC every year as it has been “cheaper” every year. Of course, that’s not how you should buy and sell stock, but I just explained the traders’ logic. So, how do I decide when to sell? I tried building distribution to see where most of the P/E ratios fall in. But with hundreds of data points, it is hard to build a meaningful distribution. Instead, I built a Pareto chart with the entire P/E ratio. Sounds fancy but easy to understand. Many of you have heard the 80-20 rule, which means 80% of effects are from 20% causes. So, the Pareto chart tries to capture that 20%. I had never learned these charts until I played with Excel recently. (I excluded negative earnings semiconductor companies as TSMC is unlikely to have negative earnings).

Based on the graph, 80% of P/E is caused by the P/E between 0-21. So, should I use the 21 as my P/E ratio? One issue with the P/E ratio is some companies have low P/E ratios because they have terrible financial performance history. When the market does not expect a company to succeed, the stock price will reflect, and the P/E ratio will also be low. So, using the lowest P/E ratio will likely underestimate TSMC, with over 40% profit margin,50% market share, and 10% revenue growth. So, I decided to use a 21-42 P/E ratio to calculate a range of price targets. The price is between $154.76 to $309.53. But the stock price can also be affected by traders’ overwhelmingly zeal to AI or underpriced due to TSMC’s consistently low P/E(around 14). So I calculated the price target with all P/E ratios (industry average, TSMC average, trailing, forward, aggregate); the power of statistics will help me. TSMC Pricing

Result: As the picture above shows, the median aggregate pricing (including third-party, historical, and my own calculated industry P/E) is $233.44. Based on my calculations, the pricing for the semiconductor industry is between $149.68 and $299.37. Based on current industry P/E and NYU forecast, the pricing is between $321.32 to $609.84. So what should I do? I don’t have to sell all in one price. I plan to sell half of my shares if the price goes to $230-$280, then sell 1/4 if it goes to $320-$280, and sell 1/8 to $320 to $609. What if it decreases? -If it decreases to $60 and buying more will not increase my TSMC investment over 4% of my total portfolio(which means I should have sold some), I will buy more. Why do I not buy based on traders pricing? As you can see from the graph of the Semiconductor industry P/E, their thumb rule keeps changing. Buying stock based on traders' prices is like buying products from convenience stores near the villa area I mentioned above based on other convenience stores' prices. What if I am wrong and it decreases more? -Buy more, if not over 4% of my total portfolio, and wait for a rebound. What if I am wrong and the stock never increases to $230 or decreases to $60 and never returns? Then I am just wrong, and I will take responsibility for it. I feel much more comfortable doing my own work to have capital gains or take responsibility rather than blaming the Fed's increasing interest rate, inflation, COVID-19, supply chain, and retail investors like investment bankers and traders. I hope you find this post to be helpful. If you don’t understand some parts, feel free to comment or send me an email. If you disagree with some parts, I would be very glad if you point them out and help me grow. If you are an accountant or investment banker who feels offended, I don’t care.