The past couple of years have been absolutely phenomenal for technology stocks, which is evident from the 90% gains clocked by the Nasdaq-100 Technology Sector index during this period, and artificial intelligence (AI) is one of the main reasons behind this outstanding surge.
After all, AI has created significant demand for hardware such as semiconductors and server components, while also creating the need for software that could be deployed in real-world situations to help users boost their productivity and improve efficiency. More specifically, the demand for AI hardware is forecast to increase at an annual rate of 31% through 2035, generating $624 billion in annual revenue.
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Meanwhile, the AI software market is expected to clock a compound annual growth rate of almost 34% over the next five years. That's the reason why we will take a closer look at the AI-related prospects of Taiwan Semiconductor Manufacturing(NYSE: TSM), popularly known as TSMC, and Twilio(NYSE: TWLO), two companies that can help investors take advantage of the growing demand for both AI hardware and software.
1. Taiwan Semiconductor Manufacturing
Semiconductors play a critical role in the proliferation of AI, with AI models being trained using chips such as graphics processing units (GPUs), central processing units (CPUs), and application-specific integrated circuits (ASICs). This is the reason why the likes of Nvidia, Advanced Micro Devices, Broadcom, and Marvell Technology are seeing robust demand for their chips.
The common link between these companies is TSMC. The semiconductor companies mentioned above are fabless in nature, which means that they simply design their chips while manufacturing is outsourced to a foundry such as TSMC. As a result, TSMC reported a terrific acceleration in its growth this year.
The Taiwan-based foundry giant's revenue in the first nine months of 2024 increased by 32% year over year. For the full year, TSMC management expects revenue to increase by almost 30%. That would translate into a top line of $90 billion based on the company's 2023 revenue of $69.3 billion. It is worth noting that TSMC's revenue contracted almost 9% last year as the company struggled due to poor demand for smartphones and personal computers (PCs).
However, the arrival of a new catalyst in the form of AI has turned around TSMC's fortunes remarkably in 2024, which is evident from the impressive growth it has clocked in the first nine months of the year. That's not surprising, as the demand for AI chips has simply taken off, with Future Market Insights estimating that this market could clock an annual growth rate of 26% over the next decade.
This puts TSMC in a terrific position to clock robust growth for years to come considering that it manufactures chips for the major players in this market. Moreover, TSMC is the world's leading foundry with a market share of 62%, according to Counterpoint Research. This further reinforces the fact that the company is set to play an important role in the growth of the AI chip market in the long run.
However, this isn't where TSMC's AI-related prospects end. The company also manufactures chips for consumer devices such as smartphones and PCs. AMD, Apple, and Qualcomm use TSMC's fabrication plants for manufacturing chips for their products. With the demand for AI-enabled smartphones and PCs set to take off, this could turn out to be another lucrative growth driver for TSMC.
All this explains why analysts are forecasting TSMC to clock healthy earnings growth moving forward.
TSM EPS Estimates for Current Fiscal Year Chart
More importantly, investors can buy this stock at an attractive 21 times forward earnings right now, which is a discount to the Nasdaq-100 index's forward earnings multiple of 30 (using the index as a proxy for tech stocks). So, investors looking to add an AI stock to their portfolios in November should definitely take a closer look at TSMC as it has the potential to deliver more upside.
2. Twilio
Twilio operates in the communications platform-as-a-service (CPaaS) market, offering application programming interfaces (APIs) to customers, by which they can connect with their customers through multiple channels such as voice, video, chat, email, and others. The company also provides a customer data platform by which it creates a centralized database containing all the interactions a company has with its customers.
Twilio is now using AI to help its clients improve their customer service experience as well as sales by combining its expertise in communications with customer data. The company pointed out on its latest earnings conference call that it is "embedding AI and machine learning throughout the Twilio platform," a move that it says will allow it to "automate capabilities, boost productivity, and drive personalization at scale."
Management added that customers who have started using Twilio's AI tools saw an improvement in their sales performance. CEO Khozema Shipchandler said on the earnings call:
The company recently ran an email campaign targeting customers most likely to purchase Apple products and saw a 592% increase in sales per email, this is just one of the many examples of the unique value that Twilio offers, helping brands create better engagement, deliver greater value and build more trusted customer experiences.
The adoption of AI tools by Twilio customers is now driving an improvement in the company's sales. It reported third-quarter revenue growth of 10% year over year to $1.13 billion, a nice improvement over the 5% year-over-year growth it recorded in the same quarter last year. Even better, Twilio's addition of AI tools to its platform is encouraging customers to spend more money.
This is evident from its dollar-based net expansion rate of 105% for the third quarter, which was again an improvement over the year-ago period's reading of 101%. A dollar-based net expansion rate of over 100% means that Twilio's existing customers increased their usage of the company's solutions, or adopted more of its offerings. That's because this metric compares the spending by Twilio's customers in a quarter to the spending by the same set of customers in the year-ago period.
The improved customer spending and Twilio's focus on keeping costs in check are the reasons why its earnings increased at an impressive rate of 76% from the same period last year to $1.02 per share in the previous quarter.
Consensus estimates expect Twilio's earnings to increase at an annual rate of almost 20% for the next five years, which means that its bottom line could hit $6.09 per share in 2028 (using 2023 earnings of $2.45 per share as the base).
Assuming it can hit that mark over the next five years and trades (at that time) in line with the Nasdaq-100 index's forward earnings multiple of 30, its stock price could hit $183. That would be a 110% increase from current levels.
Twilio currently trades at just 22 times forward earnings, which means that it is attractively valued. Investors have an opportunity to buy it before it surges higher following its latest quarterly report.
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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices, Apple, Nvidia, Qualcomm, Taiwan Semiconductor Manufacturing, and Twilio. The Motley Fool recommends Broadcom and Marvell Technology. The Motley Fool has a disclosure policy.
