We recently compiled a list of the 10 Stocks Hedge Funds Are Crazy About Right Now. In this article, we are going to take a look at where Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) stands against the other hedge fund-approved stocks.

Investing, broadly speaking, narrows down to two strategies. These see an investor decide whether to buy a stock for the short term and make quick profits or hold it for years to patiently wait for the returns to accrue. One of the most successful investor of our times, Warren Buffett (see his latest portfolio), is an ardent follower of the latter approach, and his wealth bears testament to his success.

Of course, deciding to pick the right stocks to sit on for years isn’t easy or else everyone would be rich by now. However, there are ways in which one can gain an edge over others. One such way is to see what the professionals are doing and then emulate their strategy. At Insider Monkey, we get right at the heart of investing by picking out the top stocks that hedge funds are investing in. Why hedge fund stock picks? Well, these professionals, who almost often charge an arm and a leg for their services, conduct extensive due diligence to pick out the right set of stocks. After all, no one would invest with a hedge fund if the fund was simply picking stocks by flipping a coin.

Yet, while due diligence is great and necessary to protect investors, investing, at the end of the day, is all about returns. By the looks of it, the funds do seem to know what they’re doing. Last year, the top ten hedge fund stock picks ended up outperforming the S&P benchmark stock index by 48.9 percentage points. In other words, while the index returned 26.1% in 2023, the top ten stocks returned 75.1% through price gains. This trend is also present in the top 30 hedge fund stocks of 2023 as these posted 53.2% in gains to outperform the S&P by 27 percentage points. Unsurprisingly, year to May 29th, the top 30 hedge fund stocks of 2024 led the S&P’s 11% and posted 20.2% in gains.

Unfortunately, though, data shows that as of 2021 end, 14% of the stock market was made of active funds while 16% was accounted for by passive funds. Compared to passive funds accounting for 8% of the market a decade ago with 20% belonging to active funds, it’s clear that the broader public believes that shifting to passive is a safer investment approach. After all, while everyone wants to make money, no one wants to lose it either.

But what if one could make their own investing decisions and gain an inside track to investing by figuring out what stocks most hedge funds have invested in? Well, at Insider Monkey we regularly compile data from more than 900 hedge funds to see where the smart money is headed. This is how we know that the top hedge fund stocks outperformed the benchmark index last year, and it’s also a strategy that’s helped us beat the market over the last 10 years. Compared to the SPY’s 235.6% in returns between 2014 and May 2024, the 10 most popular stocks among hedge funds returned 463.7%.

But wait. At this point, you could argue that since hedge fund SEC filings come with a 45 day lag, perhaps they aren’t that important. After all, it might be more important to know what the funds are doing now. Well, since we’ve been compiling top hedge fund stocks since 2012 in our quarterly newsletter, we can guarantee you that the top hedge fund stocks haven’t changed by much since 2018. So not only isn’t the time lag that significant, but by subscribing to our newsletter, you can gain an early track to see which stocks are falling out of favor among the funds as well.

So, all this talk about the top hedge fund stocks might make you wonder about the stocks themselves. Curious? Check out the 31 Most Popular Stocks Among Hedge Funds. We also cover legendary investors through pieces such as Warren Buffett’s 12 Longest Held Stocks.

Our Methodology

To make our list of the top ten hedge fund stocks, we scanned Insider Monkey’s database of 900+ hedge fund filings for Q1 2024 and picked out the stocks with the highest number of investors.

Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM)

Number of Hedge Fund Investors In Q1 2024: 135

Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) is a contract manufacturer responsible for manufacturing most of the world’s made to order chips. The firm’s competitive advantage and moat depends on its ability to keep its leading in the semiconductor fabrication race. TSMC’s latest manufacturing process right now is the 3-nanometer process, and the firm is also facing competition from rivals Intel and Samsung. While Intel’s advanced manufacturing processes, and its effort to establish a contract manufacturing division called Intel Foundry, will come online in the next couple of years, Samsung currently offers comparable products to Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM)’s technologies. However, the Taiwanese firm continues to retain the bulk of global semiconductor manufacturing orders, and its role will become more crucial in the current AI wave.

Third Point Management mentioned Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) in its Q1 2024 investor letter. Here is what the fund said:

During the quarter, we added to our TSMC investment, which we initiated in May of last year. TSMC is coming off its worst year since the Global Financial Crisis, and in the years to come we see a combination of cyclical recovery plus structural growth in AI demand fueling substantial earnings growth for the company.

We view TSMC as the “toll road” of the semiconductor industry, particularly for AI compute. TSMC holds more than 90% market share for leading edge semiconductor manufacturing, where all AI silicon is being processed. Beyond their reliable execution producing some of the most complex products on earth in volume, TSMC has spent decades optimizing for and building ecosystems around their 500+ customers, an advantage that cannot be replicated overnight.

Today, TSMC derives a relatively small percentage of its revenues from AI processors, largely from NVDA, but we see that percentage quickly rising as AI compute broadens from just the GPU to custom accelerators. With Nvidia’s GPUs costing tens of thousands of dollars, the bulk of which go to Nvidia’s gross profit, hyperscalers are doubling down on their efforts to develop in-house silicon to alleviate AI compute’s economic burden. Google was the first mover to custom accelerators with the TPU almost 10 years ago, and today this is already a multi-billion dollar business for TSMC. Amazon, Microsoft, and Meta have all followed Google’s lead and have announced (and in Amazon’s case already mass producing) their own chips. As these products scale, we see TSMC’s AI revenue growing by multiples in the coming years.

While TSMC’s fundamental outlook looks bright, the market has concerns which are reflected in the stock’s 10x+ discount to the SOX, the widest in TSMC’s history. The main concern is Intel’s entry into the foundry market. While we commend Intel’s efforts to diversify the global semiconductor supply chain and have admiration for the company’s rich IP and manufacturing expertise, we think it will be difficult for Intel to challenge TSMC’s dominance in foundry. Putting aside the onerous capital requirements necessary to stand up a foundry business (TSMC’s capital budget stands at ~2x Intel’s projected EBITDA), we believe the transition from internal manufacturing to an external foundry will be a difficult one. Intel has spent the past 40+ years tailoring its manufacturing process and transistor design to suit its own narrow product suite. Broadening to a multitude of customized external customer designs across a variety of end markets, in particular mobile, we believe will prove challenging.

We believe TSMC has significant untapped pricing power which can be levered to offset (if not expand) its already admirable returns on capital.

Overall TSMC ranks 10th on our list of the best hedge fund-approved stocks to buy. You can visit 10 Stocks Hedge Funds Are Crazy About Right Now to see the other hedge fund-approved stocks that are on hedge funds’ radar. While we acknowledge the potential of TSMC as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than TSMC but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

READ NEXT: Analyst Sees a New $25 Billion “Opportunity” for NVIDIA and Jim Cramer is Recommending These 10 Stocks in June.

Disclosure: None. This article is originally published at Insider Monkey.