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Taiwan Semiconductor: A High-Tech Stock With a Promising Dividend Base

Will its free cash flow status affect its future returns? Continue reading... Read More...

Yes, we would all like to enjoy the growth of high-tech stocks, as they continue to dominate the S&P 500. But for prudent investors, high-tech suggests high risk, and that’s not good.

Is there a stock that allows us to reach for the big returns without taking on a lot of risk?

Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE:TSM) offers big-tech types of gain and has a five-year dividend yield on cost of 8.52%. Regarding capital gains, this 10-year chart shows the company has delivered a six-fold increase in its share price:

It claims its scale and high-quality technology generate robust operating margins, and despite being in the highly competitive foundry business, that its shift to the fabless business model has given it tailwinds. It also boasts of global customers, including such notable companies as Apple (NASDAQ:AAPL) and Nvidia (NASDAQ:NVDA).

GuruFocus gives it these overall ratings:

  • Predictability (of revenue and earnings growth): 3 out of 5
  • Financial strength: 8 out of 10
  • Profitability: 9 out of 10
  • Valuation: 2 out of 10

In the latest annual report to investors, Chairman Mark Liu and CEO C.C. Wei noted that the 5G protocol (and the internet of things that goes with it) is an important driver of growth: “We expect a faster worldwide penetration of 5G smartphones with higher silicon content over the next several years. The need for higher power efficiency, speed and more complex functionalities in 5G smartphones will lead to increasing use of TSMC’s leading edge technologies.” To support its opportunities in this area, it raised its 2019 capital spending to $14.9 billion.

Overall, we’re left with the impression that Taiwan Semiconductor is a strong company with opportunities for growth.

Next, we analyze the company’s dividend quality and reliability to try to determine if that 8.52% yield on cost is realistic. We use data from the Dividend & Buy Back section of the summary page:

GuruFocus Taiwan Semiconductor dividend table

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Dividend yield” data-reactid=”41″>Dividend yield

The table tells us the current yield is 2.77%.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="What does that mean? First, it is modestly higher than the S&amp;P 500 average. Second, the green bar shows it is paying a higher dividend than most of its peers. GuruFocus reports that its dividend is higher than 81% of the 434 companies in the semiconductor industry.” data-reactid=”43″>What does that mean? First, it is modestly higher than the S&P 500 average. Second, the green bar shows it is paying a higher dividend than most of its peers. GuruFocus reports that its dividend is higher than 81% of the 434 companies in the semiconductor industry.

The red bar indicates the dividend yield is not as high as it has been in the past. According to GuruFocus, the current yield is well below its 10-year high: “NYSE:TSM’ s Dividend Yield % Range Over the Past 10 Years: Min: 1.95 Med: 3.31 Max: 10.18.” The maximum may have occurred when the share price plunged, along with the rest of the market, earlier this year.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Dividend payout ratio” data-reactid=”45″>Dividend payout ratio

At 94%, the dividend payout ratio is relatively high; it means that 94% of its earnings are going to dividends.

In some cases, we would question the sustainability of the dividend, however, the 94% level appears to be a blip. In the preceding nine years before 2019, the payout ratio varied between 39% and 59%, which is a comfortable range.

Where did that blip come from? The company offers no explanation in its reporting. However, we know that the payout ratio is calculated by dividing dividends per share by earnings per share before non-recurring items.

This chart shows the relationship between dividends per share and earnings per share:

GuruFocus Taiwan Semiconductor dividends and earnings chart

We find the answer in that relationship: During 2019, the dividends per share kept increasing while the earnings line flattened out. At the end of 2019, the dividend was $2.05 while the earnings (per share) were $2.26, a 21-cent difference. A year earlier, the difference was 97 cents.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Dividend growth rate” data-reactid=”62″>Dividend growth rate

The chart showed a strong upward trend for dividends from 2016 and, over the past three years, the dividend growth rate has been 18.6% per year.

To put that into perspective, we know from using the rule of 72 that the dividend will double in 3.8 years. That’s very fast, so we must ask ourselves if it is sustainable. To check, we look at the trend in free cash flow:

GuruFocus Taiwan Semiconductor free cash flow chart

That’s not the kind of chart that would make an investor confident that Taiwan Semiconductor can continue to grow its dividends at 18.6% per year. Margins may be strong, but they haven’t translated into free cash flow.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Forward yield” data-reactid=”81″>Forward yield

When the forward yield is greater than the trailing 12-month yield, as it is here at 5.04% versus 2.77%, then we expect to find that the most recent dividend was worth more than those of the previous year.

And, indeed, that is the case since the dividend data shows an increase from 41.7 cents to 42 cents.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Five-year yield on cost” data-reactid=”84″>Five-year yield on cost

Finally, on the dividend table, we look at Taiwan Semiconductor’s projected yield on cost over the next five years. It is substantial at 8.52% per year.

But it is only realistic if the company can finance higher dividend payments. As we saw in the dividend growth rate section, the company needs to get its free cash flow back on track before we can feel confident about the yield on cost.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Buybacks” data-reactid=”87″>Buybacks

There is no reference to buybacks in the table, suggesting the company has not bought back any of its shares in the past three years.

When we look at a graph of shares outstanding over the past 10 years, we see a remarkably stable trend, with no buying and no new issuances:

GuruFocus Taiwan Semiconductor shares outstanding

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Valuation” data-reactid=”101″>Valuation

Taiwan Semiconductor’s valuation rating at GuruFocus is just 2 out of 10, telling us that this stock is no bargain. It might have been recently, but the price chart shows that moment has passed:

GuruFocus Taiwan Semiconductor price chart

The discounted cash flow calculator finds it to have a negative, -12.6%, margin of safety. The PEG ratio at 3.32 argues that the valuation is too high. The price-earnings ratio is 22.31, down from the high 20s at the beginning of the year.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Gurus” data-reactid=”115″>Gurus

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Nineteen of the GuruFocus gurus have positions in Taiwan Semiconductor. Ken Fisher (Trades, Portfolio) of Fisher Asset Management had 29,674,267 shares on March 31. First Eagle Investment (Trades, Portfolio) had 10, 126,647 shares and Sarah Ketterer (Trades, Portfolio) of Causeway Capital Management had 6,237,317 shares.” data-reactid=”116″>Nineteen of the GuruFocus gurus have positions in Taiwan Semiconductor. Ken Fisher (Trades, Portfolio) of Fisher Asset Management had 29,674,267 shares on March 31. First Eagle Investment (Trades, Portfolio) had 10, 126,647 shares and Sarah Ketterer (Trades, Portfolio) of Causeway Capital Management had 6,237,317 shares.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Conclusion” data-reactid=”117″>Conclusion

Investors who have owned Taiwan Semiconductor since 2010 have enjoyed an exciting ride, as the company grew both its share price and its dividend payments.

For aggressive investors, this may be an opportunity to get a potential 8.5% per year on dividends alone, before capital gains.

Income investors, on the other hand, will be cautious about this name because of its unsteady cash flow, and a share price that leaves no room for error.

Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.

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<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="This article first appeared on GuruFocus.
” data-reactid=”129″>This article first appeared on GuruFocus.

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