On today's segment of Good Buy or Goodbye, Pence Capital Management chief investment officer Dryden Pence joins Yahoo Finance's Julie Hyman to discuss navigating stock picks within the semiconductor sector. Pence shares his perspective on why investors should consider adding Taiwan Semiconductor Manufacturing Co. (TSM) to their portfolios while avoiding Intel (INTC).

Pence identifies Taiwan Semiconductor Manufacturing Co. as a buy, highlighting the company's position in the world of artificial intelligence (AI). He explains that Taiwan Semi produces "really high-value" chips, making it an "absolute chokepoint" in the industry. Pence goes so far as to dub the company the "most important" player in this space, as he believes "no one is able to accomplish their long-term mission" without relying on Taiwan Semi's capabilities. This, in turn, grants the company pricing power and the potential for "long-term excess earnings." Additionally, Pence emphasizes Taiwan Semi's technological superiority over its competitors, describing the company as an "essential building block" in the future of AI.

In contrast, Pence recommends that investors steer clear of Intel. He notes that the legacy business has "lost its mojo," and with a lack of meaningful innovation efforts Intel's once-dominant foundry business, which accounted for 61% of the market, "has fallen dramatically." With competitors now "years ahead" in terms of innovation, tights supply chains, and surging demand, Pence explains companies are hesitant to "disrupt something that's working," resulting in a decline in Intel's market share.

For more expert insight and the latest market action, click here to watch this full episode of Market Domination.

Disclosure: Dryden Pence personally owns shares of TSMC.

Editor's note: This article was written by Angel Smith

Video Transcript

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JULIE HYMAN: It's a big noisy universe of stocks out there. Welcome to "Good Buy or Goodbye." Our goal to help cut through that noise to navigate the best moves for your portfolio. Today, we're digging into the highly-competitive semiconductor industry.

So what's the best way to play your asset allocations? Let's bring in Dryden Pence, chief investment officer for Pence Capital Management. Thanks for being here. Appreciate it.

DRYDEN PENCE: Absolutely. Great to be here. Thanks for having me.

JULIE HYMAN: Let's get straight to your buy here. And it is Taiwan Semiconductor, which has been much in the headlines as of late, but really always is when we have the semiconductor conversation. The stock's done well over the past year. And you actually call it the world's most important company, which definitely stood out to me in your notes on the segment here. Why is it the world's most important company?

DRYDEN PENCE: Taiwan Semi occupies a very key place in everything that has to happen with AI. When you think about chips, our demand for chips, our demand for data is going to be five times greater in 2025 than it was in 2019. The fact is that 90% of the really high-value chips and the really important ones are made by Taiwan Semi.

So they're the absolute choke point. They're 30% of the cost of goods sold of AMD and NVIDIA as well. So they're absolutely essential to everything that's happening in AI and in chips going forward.

JULIE HYMAN: Yeah. And as you also point out, the market share is pretty massive here when we were talking about the most advanced chips. And just to be clear to viewers who are not familiar, because we talk about semiconductor companies all the time, Taiwan is a so-called foundry. So they're actually physically making the chips that other companies design.

DRYDEN PENCE: Exactly. And because they are and because they're that foundry, they're just absolutely-- we call it the choke point, right? No one is able to accomplish their long-term mission without using Taiwan Semi. So that gives them pricing power and pricing power is going to turn into long-term excess earnings. So that's one reason why we like the stock for short term, long term, and all the way through.

JULIE HYMAN: Interesting. And that 90% market share is just astonishing. And then finally, as well, you say their technology is far ahead of competitors. Because there are certainly other companies who are in the business, but they're not close in size.

DRYDEN PENCE: Exactly. And they're able-- Taiwan Semi has this unique ability to build upon their successes and, kind of, maintain their initiative in this. So as they working through not only their processes, but where they are, but their technology. And their fully integrated into all the other big players. No one can really do their business without Taiwan Semi.

So because of that we think that they're going to continue to have this continual product renewal when you think of-- I think of Moore's law even, as things get better. So I think when you think of it as a foundry, it's the absolute essential building block for the future of AI.

JULIE HYMAN: Interesting. OK, so as we always do, we like to talk about what could be a potential risk. And we got a little bit of a renewal of this conversation over the past week. Now, you say the risk is the geopolitical issue. Obviously, there was an earthquake in Taiwan as well, which thankfully did not damage the production capacity it seems. But it did renew this idea that we are so reliant on this company and its operations in Taiwan.

DRYDEN PENCE: Well, I mean, it is a geographic risk. It's a geopolitical risk. I think they're working to move production out of Taiwan to globally diversify. That will certainly help earthquakes, but it will also help the situation with the risk of a China conflict.

So I think that when we look at how they're going to do this, they're able to take their capital, deploy it globally, and bring their technology into various other places. I mean, we learn from COVID why it's important to have supply chains more localized as opposed to completely globalized. So with regards to Taiwan Semi, I think the point is moving their production outside of Taiwan to other places of the world ameliorate that particular risk, as well as put us in a situation where we don't have that same constriction whether it's famine, disease, COVID, earthquake, whatever it is.

JULIE HYMAN: What have you. And just quickly, before we move on to the stock you're avoiding, do you have a position in TSMC?

DRYDEN PENCE: Yes, we do.

JULIE HYMAN: OK.

DRYDEN PENCE: Yes, we do we do and many of our clients do.

JULIE HYMAN: OK, gotcha. So let's move on to the stock you don't like that is trying to compete with Taiwan Semi, we should say, and that is Intel. And as we know, the stock has had a bit of a rocky ride, especially recently. So firstly, there's the legacy business.

DRYDEN PENCE: Right. And if you look for a company that's, kind of, you could say they lost their mojo, it's Intel. And the problem that they have is really for the longest time, they were so dominant. I think they just got-- maybe they got lazy? Maybe they just didn't innovate enough.

But whatever it is, they're losing market share to Taiwan Semi. They're losing market share to anybody else in the business. And they're really not able to keep up with their innovation and I think that that's really important.

You can take a look at companies over time that, kind of, lose their ability to innovate. I mean, you can look at IBM or something like that, massively dominant at one point and then they become less effective. And so we worry about Intel in that sense. They're really going to have to work hard to reassert themselves.

JULIE HYMAN: Yeah, although you could argue IBM has come back again so maybe at some point. And one of the ways Intel is trying to do that is to build its foundry business so basically to more directly compete with the likes of a Taiwan Semi and others by making its own manufacturing capacity.

DRYDEN PENCE: Exactly. And I think that they-- at one point, they were 61% of the market. But now they've fallen dramatically, right?

So now they're going to have to redeploy and work directly to increase their foundry capabilities. They're trying to compete with Taiwan Semi, but Taiwan Semi is so many years ahead of them. So when you-- not only do we look at it as one to avoid in and of itself, but we certainly look at it as one to avoid in contrast and in comparison to the other players because they're really years ahead of them.

JULIE HYMAN: And as you point out, Intel just came out with an update as well with some numbers around the foundry business that disappointed the market.

DRYDEN PENCE: Yeah and they're losing money. I mean, the short answer is, yeah, we're trying to make a huge investment in this, but we're losing money and we're not really catching up. And I think that that's one of the big things. I mean, their losses ballooned over up to $7 billion in this segment. So I think you have to be careful with this and that's one reason why it's on the avoid list.

JULIE HYMAN: Yeah. And then one last thing that is the other point of contrast with Taiwan Semi is the dominance with major industry customers and that technological edge that you pointed out.

DRYDEN PENCE: Exactly. And I think when you take a look at Qualcomm, AMD, Broadcom, all the other-- those companies where 30%, 40% of their cost of goods sold is with TSMC. And you see Intel trying to move into that.

The problem is supply chains are so tight, demand is so high, people are not going to want to disrupt something that's working. So it's going to be very hard for Intel to get back in to those systems. And I think that they've just got a hard road to go. Now, that doesn't mean they can't do it, right? They probably can, but I don't think that-- I don't think they're going to catch up with someone like TSMC anytime soon.

JULIE HYMAN: Gotcha. And I guess that last point is, sort of, the risk to the downside. What could go right? Well, it could work, the foundry--

DRYDEN PENCE: It could work.

JULIE HYMAN: --effort and maybe work better and sooner than some investors [INAUDIBLE].

DRYDEN PENCE: I think the biggest thing, I mentioned earlier how we see this five-fold increase in demand for data between 2019 and 2025. I mean, AI and everything, there's more data demand, more chips demand. It's in everything. I mean, there's chips in electric toothbrushes, you know, I mean, when you get into it.

And what can go right for them is that this just tremendous demand is there and maybe they're second, or third, or fourth place. But second, or third, or fourth place is still profitable when demand is massive, right? And so I think that's the thing that can go right in this scenario--

JULIE HYMAN: Gotcha

DRYDEN PENCE: --is that you just-- TSMC can't keep up, and other people can't keep up, and so there's enough to go around. And so their business is going to be OK.

JULIE HYMAN: It's not a zero sum--

DRYDEN PENCE: Exactly.

JULIE HYMAN: --game in other words.

DRYDEN PENCE: It's an ever expanding pie.

JULIE HYMAN: Yeah. Position in Intel?

DRYDEN PENCE: Very, very minor. Very, very minor.

JULIE HYMAN: OK, gotcha.

DRYDEN PENCE: Only legacy positions that are held onto for tax reasons.

JULIE HYMAN: OK, so let's summarize what you're telling folks here. Basically, you say buy Taiwan Semiconductor as it's a key AI choke point, the most important company in the world for that reason, dominates market share, years ahead of its competitors technologically. On the other side, you say avoid Intel. It has lost its technological edge and that foundry segment is not yet up to snuff.

Thanks so much. Appreciate it, Dryden.

DRYDEN PENCE: Absolutely. Thank you.

JULIE HYMAN: And Thank you for watching "Good Buy or Goodbye." You can catch episodes here three times a week at 3:30 PM Eastern.

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