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Taiwan Semiconductor Manufacturing’s (NYSE:TSM) Capital Allocation points to Better returns Ahead

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This article originally appeared on Simply Wall St News.

Shares of Taiwan Semiconductor Manufacturing ( NYSE:TSM ) responded well to third quarter results which were released last week. But the share price remains in an overall downtrend that began in February.

Q3 Earnings Highlights:

  • Revenue of $14.88b, $140m ahead of consensus and up 22.5% year-on year.

  • GAAP EPS of $1.08, $0.05 ahead of consensus and up 20% year-on-year.

  • Gross and operating margins ahead of consensus and improved from Q2.

TSMC has underperformed the market and the semiconductor industry by as much as 20% since February, and the share price is up just 6% YTD. Quite a few semiconductor companies have struggled this year. This is partly due to the chip shortage affecting customers, and partly due to strong price performance in 2020. In TSMC’s case the share price rose 85% in 2020, and is up 273% over the last 5 years (excluding dividends).

TSMC’s share price might also be moving sideways because the outlook doesn’t stand out from the industry or the broader market. The following chart illustrates the earnings and revenue growth outlook for TSM, the Semiconductor Industry, and the US equity market.

NYSE:TSM Analyst Future Growth Forecasts October 18th 2021
NYSE:TSM Analyst Future Growth Forecasts October 18th 2021

With expectations broadly in line with the industry and the market, there doesn’t appear to be a reason to take on the risk currently associated with chip stocks. TSMC doesn’t appear to be overvalued, but also doesn’t appear cheap relative to the expected growth rate.

While the immediate future doesn’t look very exciting, we can look at how well the company is allocating capital. This will give us an idea of how well TSMC can compound earnings in the future. To do this we can calculate the Return on Capital Employed (ROCE).

What is 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)

0.23 = NT$625b ÷ (NT$3.3t - NT$656b) (Based on the trailing twelve months to September 2021) .

Therefore, Taiwan Semiconductor Manufacturing has an ROCE of 23% . That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry. For context, amongst the large semiconductor producers, only Qualcomm ( NASDAQ:QCOM ), Texas Instruments ( NASDAQ:TXN ), and Advanced Micro Devices, Inc. ( NASDAQ:AMD ), have a higher ROCE.

Check out our latest analysis for Taiwan Semiconductor Manufacturing

roce NYSE:TSM Return on Capital Employed October 18th 2021
roce NYSE:TSM Return on Capital Employed October 18th 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.

So How Is TSMC's ROCE Trending?

We'd be pretty happy with returns on capital like Taiwan Semiconductor Manufacturing. The company has consistently earned 23% for the last five years, and the capital employed within the business has risen 83% in that time. Now considering ROCE is an attractive 23%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns.

Our Take On TSMC’'s ROCE

TSMC’s ROCE is impressive both in absolute terms and in comparison to its peers. This bodes well for future growth prospects. But capital allocation is just one aspect of a company to keep an eye on. Our latest analysis for Taiwan Semiconductor Manufacturing covers other important information like valuation, past performance, ownership and key risks to be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

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