DIY investors are heavily backing the companies that design AI semiconductors but are yet to acknowledge the company that actually manufactures them.
At the start of the month, investors rushed to buy shares in semiconductor designer AMD after the company announced it had made a graphics processing unit (GPU) to rival Nvidia’s H100. In the presentation in California, chief executive Lisa Su said AMD’s MI300X chip is the “most advanced AI semiconductor in the industry”.
Unsurprisingly, that same week there were record retail inflows to AMD, according to Vanda Research. This year, with falling inflation and the emergence of AI, trading from US DIY investors has picked up and they are particularly interested in semiconductor designers AMD and Nvidia.
This makes sense. Since its launch at the end of last year, Chat GPT has been the fastest-growing consumer software product ever. It now has close to 200mn users globally. As of August, 18 per cent of American adults had used ChatGPT, according to Pew Research. This figure will be higher for private investors who are likely more curious than the average American.
Once you have used a product, it is easier to understand the hype. Blockchain and the metaverse all flopped with investors because their use cases needed to be imagined. In the case of AI chatbots, it is obvious what they do. Most investors understand that for more AI products to emerge, the world needs to build many more semiconductors and super computers.
However, such investors have yet to dig further into the supply chain. AMD might be seeing record inflows but TSMC, the company that manufactures almost all these chips, saw its largest DIY investor outflows in two years that same week, according to Vanda. They design them and then outsource the manufacturing to other companies. In the case of the high-end AI chips, this is done by TSMC in Taiwan.
The monopoly of these high-end chips allows TSMC to charge large prices. Its operating margin is almost always more than 40 per cent and has occasionally gone as high as 50 per cent. This year growth has slowed because it still relies on demand from consumer electronics, which has taken a hit. In the three months to September, revenue was down 11 per cent to $17.2bn. However, this needs to be seen in the context of the long-term. In the same period in 2019, revenue was just $9.4bn.
Despite this remarkable financial performance, TSMC only trades on a forward price-to-earnings ratio of 16. For comparison, AMD is trading on a forward PE of 37. Yet, AMD’s operating profit margin is rarely above 20 per cent and it is also still heavily reliant on the consumer market, with over a fifth of its revenue coming from PCs
It is not obvious why investors avoid TSMC while heavily backing Nvidia and AMD. The generous view is it is strategic and they have carefully weighed the threat of a Chinese invasion of Taiwan and decided the risk is too great.
However, ultimately this is a decision that will be made in the head of one dictator, and no one knows other than him what will happen. Anyway, AMD and Nvidia would both be crippled in this scenario given they would be unable to manufacture any of their most advanced chips, so it shouldn't explain the valuation difference.
The more damning view is that either US retail investors are too nationalistic to look beyond their own shores, or are unaware of how the semiconductor supply chain operates. Investors clearly see the importance of AI, but they are looking past the best value parts of the supply chain.
