TSMC: Moore or less?

Moore's strong generalisation that holds for 50 years or so and then wobbles because you can only make things so tiny does not have the same ring to it as Moore's Law. It might turn out to be more accurate. The law states that the number of transistors that can be crammed on to a bit of silicon doubles roughly every two years. A corollary is that as the transistors shrink, the per-transistor cost of manufacture falls at a similar rate - halving every two years. This is key to chipmakers' business model: it means they can deliver the same chip at half the price, or a twice-as-powerful chip at the same price, on a regular cycle.

Recently chipmakers, and makers of equipment for chip foundries, have hit delays as they pushed toward the next step of miniaturisation. And the manufacturing costs have not been falling as fast as Moore's law would predict: Morgan Stanley estimates that in the past few cycles, costs have fallen closer to 30 per cent than 50 per cent.

Technology surprises people. The law may yet hold. But higher manufacturing costs could cast some doubt on a stock that might offer the best combination of growth and value out there: chipmaker TSMC. In its latest quarter, it reported 50 per cent sales growth. Its price to earnings ratio is a below-market 12. Its return on capital is north of 20 per cent. It carries no debt. Growth will be much slower for the rest of this year, but its business model - it mostly makes chips for other chipmakers without foundries of their own - has proved very resilient over the long run. But if costs quit their decline, margins at TSMC (and the rest of the industry, from Intel down) will fall.

There is another long-term worry. More than half of TSMC chips go into smartphones. That market is growing, but most of the growth is at the lower end. High-end phones have $40-$50 of advanced silicon chips in them, Bernstein estimates; in a low-end smartphone, the figure is $10-$20. So the price trend is not, in this case, TSMC's friend.

These are real threats. Even so, TSMCs valuation and record support this generalisation: keep an eye on margins - and hold on to the stock.

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